Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
2010 ANNUAL REPORT
CHAPTER A - OVERVIEW OF THE ENTITY'S BUSINESS
CHAPTER B - DIRECTORS' REPORT
CHAPTER C - 2010 FINANCIAL STATEMENTS Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
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2010 ANNUAL REPORT
CHAPTER A OVERVIEW OF THE ENTITY'S BUSINESS
Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
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Chapter A Description of the Corporation’s Business
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Table of Contents CHAPTER 1: GENERAL ...... 4
CHAPTER 2: DESCRIPTION OF THE GENERAL DEVELOPMENT OF THE CORPORATION’S BUSINESS ...... 7
1. THE CORPORATION’S ACTIVITIES AND A DESCRIPTION OF THE BUSINES'S DEVELOPMENT ...... 7 1.1 General ...... 7 1.2 Holdings of the Company ...... 8 1.3 Year of Incorporation and Form of Incorporation ...... 9 1.4 Changes in the Corporation’s Business ...... 9 2. FIELDS OF ACTIVITY...... 10
3. INVESTMENTS IN THE CORPORATION’S CAPITAL ...... 10 3.1 General ...... 10 3.2 Options ...... 10 3.3 Shares Held by Company Employees ...... 12 3.4 Changes in Holdings of Interested Parties ...... 13 3.5 Table Summarizing Data on Interested Party Holdings ...... 15
4. DISTRIBUTIONS OF DIVIDENDS ...... 16 5. FINANCIAL DATA ON THE CORPORATION’S FIELDS OF ACTIVITY ...... 17 5.1 Nature of Consolidation Adjustments ...... 19 5.2 Explanation of Developments Occurring in the Fields of Activity ...... 19
6. GENERAL ENVIRONMENT AND EFFECT OF EXTERNAL FACTORS WITH REGARD TO THE COMPANY 19 6.1 Traffic in the International Aviation Industry ...... 19 6.2 Traffic in the Israeli Aviation Industry ...... 19 6.3 Fluctuations in Jet Fuel Prices ...... 20 6.4 Foreign Currency Rate Fluctuations ...... 20 6.5 Interest Rate Fluctuations ...... 21
CHAPTER 3: DESCRIPTION OF THE CORPORATION’S BUSINESS BY FIELD OF ACTIVITY ...... 21
7. THE FIELD OF PASSENGER AIRCRAFT ...... 21 7.1 General Information on the Field of Operations ...... 21 7.2 Services in the Field of Operations ...... 51 7.3 Analysis of Revenues and Profitability from Services ...... 58 7.4 New Services ...... 58 7.5 Customers ...... 61 7.6 Marketing and Distribution ...... 61
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7.7 Reservations Backlog ...... 65 7.8 Competition ...... 65 7.9 Seasonality ...... 67 7.10 Productive Capacity ...... 68 7.11 Aircraft Fleet ...... 69 8. CARGO AIRCRAFT FIELD ...... 75 8.1 General Information on the Field of Operations ...... 75 8.2 Services in the Field of Operations ...... 82 8.3 Analysis of Service Revenues and Profitability ...... 83 8.4 New services ...... 83 8.5 Customers, marketing and distribution ...... 84 8.6 Reservations Backlog ...... 84 8.7 Competition ...... 84 8.8 Seasonality ...... 87 8.9 Productive Capacity ...... 87 8.10 Aircraft Fleet ...... 88 8.11 Raw materials and suppliers ...... 90
9. INFORMATION REGARDING BOTH AREAS OF ACTIVITY ...... 90 9.1 Fixed Assets and Installations ...... 90 9.2 Insurance ...... 93 9.3 Intangible Assets ...... 94 9.4 Human resources ...... 94 9.5 Raw Materials and Suppliers ...... 119 9.6 Working Capital ...... 121 9.7 Investments ...... 125 9.8 Financing ...... 129 9.9 Taxation ...... 131 9.10 Environmental Matters ...... 134 9.11 Restrictions and Regulations on the Corporation’s Business ...... 142 9.12 Material agreements ...... 174 9.13 Cooperation agreements ...... 177 9.14 Legal proceedings ...... 178 9.15 Goals and Business Strategies ...... 184 9.16 Developments Projected for the Coming Year ...... 187 9.17 Financial Data on Geographic Segments ...... 187 9.18 Discussion of Risk Factors ...... 188
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CHAPTER 1: GENERAL
El Al Israel Airlines Ltd. is pleased to present a description of the Corporation’s business for the fiscal year ending December 31, 2010, reviewing the Corporation in general and the development of its business, as they occurred during 2010. The report was prepared in accordance with the Securities Regulations (Periodic and Immediate Reports)-1970. The financial data included in the report is in U.S. dollars, unless stated otherwise. The financial data relating to monetary claims are in Israeli shekels (“NIS”) as of the date that the claim was filed, unless stated otherwise. The percentages of ownership are presented in numbers rounded out to the nearest whole percent, unless stated otherwise. Data appearing in this report are correct as of the report date, unless stated otherwise. Data appearing in this report as correct as of a date close to the approval of this report has been updated as of March 15, 2011, unless stated otherwise. The importance of the data included in this Periodic Report, including the description of material transactions, has been assessed from the Company’s point of view, while in some cases, additional descriptive information is given in order to provide a comprehensive picture of the matter being described. This chapter, which deals with a description of the Group, its development, businesses and fields of activity, also includes forward-looking information, as defined in the Securities Law, 1968. Forward- Looking Information is information that is uncertain as to the future, based principally on existing Company information at the reporting date and includes estimates, assumptions or intentions of the Company, as of the report date, as well as estimates and forecasts of third parties, which might not be realized or only partially realized. Therefore, actual results, in full or in part, could be significantly different, positively or negatively, from the results estimated, derived or implied from this information. In certain cases, segments featuring forward-looking information may be identified by the presence of words such as “we estimate”, “we mean”, “we believe”, “we predict” and so on, but this information may also appear with different wording.
Glossary For the sake of convenience, in this periodic report, the following abbreviations shall be assigned the meaning listed alongside them:
Report of the Board of Directors - The Report of the Board of Directors on the State of Corporate Affairs for the Year Ending December 31 2010.
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USD/Dollar - U.S. dollar.
The Stock Exchange - The Tel Aviv Stock Exchange Ltd.
The Financial Statements - The Company’s Consolidated Financial Statements for the Year Ending December 31 2010, unless noted otherwise.
The State - The State of Israel.
The Group - The Company and its subsidiaries
The Authority - The Securities Authority.
The Corporation or the Company El Al Israel Airlines Ltd. or El Al -
Fifth Freedom - Transporting passengers or cargo between two foreign countries by a third country carrier. For instance, El Al transports cargo between Liege and New York
Sixth Freedom - Transporting passengers or cargo between two foreign countries with a stopover in the airborne carrier’s country. For instance, a flight by a European airline from Israel to the U.S through an airport located in that airline’s European country.
The Companies Law - The Companies Law, 1999.
The Government Companies Law - The Government Companies Law, 1975
The Securities Law - The Securities Law, 1968.
IATA - The International Air Transport Association
The Report Date - December 31 2010.
Knafaim - Knafaim Holdings Ltd.
Date immediately prior to the March 15 2011, unless noted otherwise. approval of the report -
Sun D’Or - Sun D’Or International Airlines Ltd.
Income Tax Order - The Income Tax Order (New Wording), 1961.
NIS- New Israeli Shekel
The Reported Year 2010.
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2003 Prospectus - The prospectus published May 30 2003, as revised on June 3 2003 and June 4 2003
Shelf Prospectus - The shelf prospectus published by the Company on May 30 2008, which expired May 30 2010.
ASK - Available Seat Kilometer - number of seats offered for sale multiplied by the distance flown.
ATK - Available Ton Kilometer - the available capacity for transport of passengers (translated into tonnage) and cargo multiplied by the distance flown.
RPK - Revenue Passenger Kilometer – number of paying passengers multiplied by distance flown.
RTK - Revenue Ton Kilometer – weight of paid flown cargo in tons multiplied by distance flown.
FTK- Freight Ton Kilometer – the weight in tons of paid cargo (including mail) multiplied by the distance flown
PLF - Passenger Load Factor – the occupancy rate in passenger flights (percentage of seats used).
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CHAPTER 2: DESCRIPTION OF THE GENERAL DEVELOPMENT OF THE CORPORATION’S BUSINESS
1. The Corporation’s Activities and a Description of the Business Development
1.1 General The Group is engaged primarily in the transport of passengers and cargo (including baggage and mail) by air between Israel and foreign countries, by means of passenger aircraft and cargo aircraft. The passenger aircraft of the Company carry out scheduled flights as well as charter flights. The Company serves as the designated air carrier of the State of Israel on most international routes operating to and from Israel. See Section 7.1.1, 7.1.2, 7.1.10 and 9.11.7.2 below for more on this subject and on the term “Designated Carrier”, and on the Government's decision regarding "Open Skies". The Group is engaged in activities auxiliary to its air transport activity, such as sale of duty-free products, production and supply of food primarily to its aircraft, and in the leasing of aircraft, providing security services, regular maintenance and overhaul services to aircraft of other airlines at Ben-Gurion Airport (“BGN”) and management of travel agencies abroad. The business environment in which the Company operates is the international and domestic civil aviation sector and tourism to and from Israel, which is characterized by seasonal fluctuations and a high level of competition, which becomes more severe during periods of excess capacity. In the area of passenger transport, in 2010 the Company competed with two Israeli airlines (Arkia and Israir), 59 foreign airlines operating scheduled flights, and over 60 foreign charter companies, 32 of which operated flights on a regular basis. The airlines compete in various areas, principally: fares, frequency and flight times, operational punctuality, equipment type, airplane configuration, passenger service, etc. The competition is with the airlines that maintain scheduled flights between different destinations, charter flights between those destinations and/or Sixth Freedom Flights (scheduled flights via stopover destinations in the mother country of those companies). In the field of cargo transport, in 2010 the Company competed with six airlines operating cargo planes in flights to and from BGN, in addition to C.A.L. Cargo Airlines Ltd. Additionally, the Group competes with most of the scheduled airlines that operate passenger airplanes and transport cargo in their holds. See Sections 7.8 and 8.7 below for more on competition.
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1.2 Holdings Chart The reported year saw a change in the structure of the Company’s holdings in light of the purchase of certain holdings (as detailed below) from Maman – Cargo Terminals and Handling Ltd. (for details see 9.12 below). The following is a chart of the structure of the Company’s holdings in investees active as of the date immediately prior to the approval of the report (the percentages listed in the chart express the Company’s holdings in the investee companies):
El Al Israel Airlines Ltd.
San Dor 100%
T.M.M 100%
Catit 100%
Super Star Holidays England 100%
Burnstein Kitrrs USA 100%
ACI 50%
Tour Avir (Airtour) 50%
Kavey Hoofsha (Holiday Lines) 20%
Maman – Cargo Terminals and Manual Handeling Ltd. 11.25%
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1.3 Year of Incorporation and its Form El Al Israel Airlines Ltd was incorporated as a limited liability company on November 15, 1948 under the name of El-Al Israel Airlines Ltd. changing its name to its present name on May 16, 1951.
1.4 Changes in the Corporation’s Business Until June 6, 2004, the Company was a “Government Corporation” undergoing “privatization” (as these terms are defined in the Government Corporations Law). See Section 9.11 below, “Restrictions and Regulation of the Corporation’s Business”, for additional details. In the context of the procedures for the privatization of the Company, on May 30, 2003, the Company and the State published the 2003 Prospectus, by means of which Company shares and options exercisable into Company shares were issued and sold. Within the framework of the 2003 Prospectus, the State also offered for sale shares and options to purchase shares from two series – call options (Series A) and call options (Series B). On the prospectus issue date, the State had held approximately 97.25% of the Company’s issued share capital. Immediately after issuance of the securities pursuant to the prospectus, the State's holdings in the Company dropped to 85% of the Company's issued share capital (undiluted). On June 6, 2004, after the exercising of options by Knafaim and others, the holdings of the State decreased to under 50%. Therefore, the Company was converted from a “Government Corporation” to a “Mixed Company”, as the meaning of this term is defined in the Government Corporations Law. Following the exercise of further options on December 23, 2004, the holdings of Knafaim rose to approximately 40% of the Company's issued share capital. On January 6, 2005, the majority of the members of the Board of Directors were replaced when the meeting of the Company’s shareholders, convened at the request of Knafaim, decided to appoint new board members. At the same time, the State announced the end of the term of all directors who were not external directors, who had been serving as of that date on the Company’s Board of Directors. As of the date of approval of the report, there are 12 members serving on the Company's Board of Directors (including two external directors). As Knafaim holds Company shares at a rate exceeding that held by the State, the special provisions detailed in Section 108 of the Company’s Articles of Association ceased to apply. See Section 9.11.2(k) below for additional details. To the best of the Company's knowledge, the State still holds 1.1% of the Company’s issued share capital, and therefore, the Company still holds a "mixed company” status. Likewise, the State holds a Special State Share (for information on the Special State Share and its related rights, see Section 9.11.9 below).
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2. Fields of Activity The Group’s headquarters functions on an integrated basis in the fields of activity listed below, including financial management, procurement, human resources, legal counseling, IT, security, maintenance and engineering, sales, service, marketing and advertising, land and ground operations and construction. The Group has two reported operating segments. For details see Note 37 to the December 31 2010 Financial Statements.
a. Air Transport in Passenger Aircraft In this field, the Group transports passengers as well as cargo (including mail and baggage) in the holds of passenger aircraft, as well as provides auxiliary services, such as sale of duty free products and passenger aircraft leasing. Revenues from this area of activity constituted 89.5% of all of the Group’s revenues in 2010.
b. Air Transport in Cargo Aircraft In this area, the Group transports cargo in cargo transport aircraft as well as provides auxiliary services, such as leasing cargo aircraft. Revenues from this area of activity constituted 4.4% of all of the Group’s revenues in 2010. Other than the fields of activity detailed above, the Group has additional activities that are not included in these fields, which are not material to the Group’s operations1and with total revenues
representing about 6.1% of total Group revenues for 2010.
3. Investments in the Corporation’s capital
3.1 General No investments were made in the corporation’s capital in 2010 and 2009. For details regarding the State’s commitment to cover the deficit in the Company employee compensation fund see 9.4.8 below.
3.2 Options On February 26, 2006, the Company's Board of Directors resolved to adopt the 2006 Option Plan for Company employees and executives (hereinafter: the "2006 Options Plan”), in which 17,092,129 options were allocated to 50 recipients, 10 of whom were senior Company executives and 40 other Company managers.
1 The production and supply of meals for flight passengers, providing security services, regular maintenance services and overhaul services to aircraft of other companies at BGN and management of travel agencies abroad.
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On May 23, 2006, the Company's Board of Directors decided to add 3,000,000 options to the pool of options for issuance pursuant to the 2006 Options Plan. In addition, the Board of Directors appointed the Human Resources and Appointments Committee of the Company's Board of Directors (the "Remuneration Committee”) as the administrator of the 2006 Options Program and authorized the Remuneration Committee to grant options to Company executives in accordance with the guidelines stipulated by the Board of Directors and subject to the law. In addition, the Board of Directors approved publication of an outline that was published on May 29, 2006. Following that, on December 27, 2006, the Remunerations Committee decided to grant 3,072,536 options to nine Company executives (two of whom are officers), which were granted in practice on December 31, 2006. On November 20, 2007, the Company's Board of Directors resolved to publish an outline (which was published on November 21, 2007) for the issuance of options, which returned to the pool of options that can be allotted pursuant to the terms of the 2006 Options Program, from the original quantity as detailed in the outline from February 26, 2006 and as amended on March 15, 2006 and/or from the additional quantity detailed in the outline from May 29, 2006, totaling 3,382,843 options (hereafter: the "2007 Options Plan"). Likewise, the Board of Directors approved the allotment of 2,195,852 options to 6 offerees (one of whom was an officer), if the requisite approvals are obtained. The allocation in question took place on December 26, 2007. As of March 15, 2011, the total amount of options issued under the 2006 and 2007 Options Plans (as described above) after deducting the options returned to the pool for any reason, in accordance with the terms of the plan, equals 7,772,232 options. On January 1, 2011 the second batch of options issued to executives in February 2006 (according to the 2006 Option Plan) and vested on January 2007 were cancelled and not realized. On April 30, 2009, the Company’s Audit Committee and Board of Directors approved a private allocation of 4,650,000 options to the Chairman of the Board of Directors, Mr. Amikam Cohen. The option allocation and the terms of the employment of the Chairman of the Board were approved in the general meeting of the Company’s shareholders, on June 24, 2009. On January 6, 2010 the Company’s Audit Committee and Board of Directors approved a private allocation of 9,914,382 options to the Company's CEO, Mr. Eliezer Shekedi. For details regarding the terms of the options given the Company’s Board of Directors and CEO, see Note 30.g.7 to the December 31, 2010 Financial Statements.
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In 2010, the Company listed a benefit value of $784,000 for the option plans in question, as salary expenses listed against capital reserves, based on benefit value calculations carried out
using economic models.
3.3 Shares Held by Company Employees Pursuant to the 2003 Prospectus, the State granted “Eligible Employees” (as defined in the 2003 Prospectus) the right to purchase 34,685,642 Company shares owned by the State (hereinafter: the "Employees’ Shares”). The Employees’ Shares were offered to the Eligible Employees at a price of NIS 0.91 per share. Within the framework of the tender offer the Eligible Employees purchased approximately 0.5% of the issued share capital of the Company (approximately 0.4% fully diluted). The State has also committed to sell to an employees' association, or to employees as individuals, the remaining Employees’ Shares not purchased by Eligible Employees (the "Remaining State Shares”), at 30% of the average closing price of the Company’s shares on the stock exchange during the 90 trading days preceding the exercise date, or NIS 1.30 per share, whichever is lower. On February 23, 2005, the Employees’ Association (Holdings in Trust for El-Al Employees Ltd.) acquired all of the Remaining State Shares (32,527,216 ordinary shares), for a price of NIS 0.39 per share. As of December 31, 2010, the Employees’ Association held 30,170,801 ordinary shares, representing 6.09% of the Company's issued share capital (5.81% on a fully diluted basis). As of March 15, 2011, the Employees’ Association held 29,873,179 ordinary shares, representing 6.03% of the Company's issued share capital (5.77% on a fully diluted basis). Various restrictions apply to the sale of the shares that are held by the Employees’ Association 2.
2 The following restrictions apply to the shares held by the Employees’ Association (in addition to the provisions of the tax code): a. No transaction or proceeding will be made in the shares and no power of attorney or transfer document will be conferred for a period of 24 months from the date that each purchase was completed. b. At the end of the aforementioned blockage period, the remaining shares will not be marketable and/or realizable, pledged and/or used as collateral in any manner, except by the Employees’ Association in the context of the bylaws of the Employees’ Association and/or after their release to the employee, as specified in the bylaws of the Employees’ Association. c. In accordance with the bylaws of the Employees’ Association employees of the Company and the subsidiaries have the right to sell the Company shares held for them by the association at the end of the blockage period, should any of the following occur: (1) with their retirement from work and the termination of the employee-employer relationship between them by their employer, in accordance with the bylaws of the Employees’ Association; (2) under other circumstances that are itemized in the bylaws of the Employees’ Association, such as a sale between Company employees, or upon the occurrence of exceptional personal circumstances; (3) in each year, beginning from the end of five years, the beginning of which is after the period of blockage within the framework of the prospectus has terminated, up to 20% of the shares held for them by the Employees’ Association, in a manner so that by the end of the tenth year, they may sell all of their shares.
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3.4 Changes in Holdings of Interested Parties As of December 31, 2010, Knafaim held approximately 39.33% of the Company's issued capital and 37.55% of the Company’s issued capital on a fully diluted basis. As of March 15, 2011, Knafaim held approximately 39.33% of the Company's issued capital and 37.63% of the Company’s issued capital on a fully diluted basis. The assumptions for the calculation of the percentages of ownership of capital and voting rights on a fully-diluted basis (above and hereafter: “Full Dilution”) are the exercise of all the executives' options under the 2006 and 2007 Options Plans, including the options granted the Chairman of the Board of Directors, Mr. Amikam Cohen and the Company CEO, Mr. Eliezer Shekedi, as detailed in 3.2 above. Presented below are details of transactions with respect to interested party holdings that were executed over the past 2 years:
. On April 4 2010 Levim Assets Ltd. (hereinafter: “Levim Assets”), a company owned and controlled by Yehuda (Yudi) Levi and his wife, announced that it had become a Company interested party, by virtue of its holdings, as a result of the purchase of 500,000 shares on the stock exchange. On June 10 2010 Levim Assets Ltd. ceased being an interested party in the Company by virtue of its holdings, as a result of the sale of the entirety of its shares to A.L. Aviation Assets Ltd. (“Aviation Assets”), which is an interested party in the Company that held 11,084,671 ordinary Company shares after the purchase. Aviation Assets Ltd. is held in equal portions by Levim Assets and by Miella Venture Partners, a company fully owned by a foreign trust the beneficiaries of which are the members of the Effi Arzi family. As of December 31, 2010, Aviation assets held 2.24% of the issued capital of the Company, and 2.13% of the Company’s issued capital on a fully diluted basis. As of March 15 2011m Aviation Assets held 10,481,769 shares, which constitute 2.11% of the Company's issued and paid-up capital and 2.02% of the Company's issued capital on a fully diluted basis. . In July 2009 Phoenix Holdings Ltd. (hereinafter: "Phoenix Holdings") informed the Company that it had become a Company interested party due to accumulating holdings of Phoenix Group companies (hereinafter : "the Phoenix Group"), including the Delek Group Ltd. (hereinafter: "the Delek Group") and Excellence Investments Ltd. (hereinafter)3. As of December 31 2010 Phoenix Holdings held 2.75% of the Company's issued capital and 2.63% of the Company's fully diluted capital. As of March 15 2011 Phoenix Holdings held 19,035,938 shares constituting 3.84% of the Company’s issued capital and 3.67% of the Company's fully diluted issued capital. Phoenix Holdings holds Company shares through a
3 Note that according to the immediate report issued by Phoenix on July 28 2009, it became an interested party in the Company in December 2007 but due to technical difficulties in locating the aggregate holdings rate that made the Phoenix Group a Company interested party, said notice was not provided the Company.
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nostro account, participating insurance as well as well as provident funds and provident fund management companies. As of December 31 2010 the Delek Group held 3.60% of the Company’s issued capital and 3.44% of the Company's fully diluted issued capital. As of March 15 2011 the Delek Group held 17,868,380 shares, constituting 3.60% of the Company's undiluted issued capital and 3.4% of the Company's fully diluted issued capital. As of December 31 2010 Excellence Investments held 1.03% of the Company's issued capital and 0.98% of the Company's fully diluted issued capital. As of March 15 2011 Excellence Investments held 4,658,206 shares constituting 0.94% of the Company's undiluted issued capital and 0.90% of the Company's fully diluted issued capital. Excellence Investments holds Company shares through a nostro account as well as through joint trust investment funds. On March 10 2010 the Delek Group received the approval of the Special State Share, as required by the Company's bylaws, to hold, directly and through corporations under its control, Company shares worth over 5% (but under 15%) of the Company's issued stock capital.
. Over the course of 2010, the Ginsburg Group4 conducted several purchase and delivery actions as reported by the Company. As of December 31 2010, the Ginsburg Group held 8.74% of the Company's issued capital and 8.34% of the Company’s fully diluted issued capital. As of March 15 2011 the Ginsburg Group held 43,322,989 shares constituting 8.74% of the Company’s undiluted issued capital and 8.36% of the Company's fully diluted
issued capital.
. Over the course of 2010, Ms. Tamar Moses-Borowitz (Deputy Chairperson of the Company's Board of Directors and Company controlling shareholder) conducted several stock purchase actions. As of December 31 2010, Ms. Tamar Moses-Borowitz held 0.41% of the Company's issued capital and 0.39% of the Company's fully diluted issued capital. As of March 15 2011 Ms. Tamar Moses-Borowitz held 2,024,517 shares constituting 0.41% of
the Company’s issued capital and 0.39% of the Company's fully diluted issued capital.
. Over the course of 2010, the El Al Employees Trust Company Ltd. (hereinafter: “the Employee Corporation”) conducted several sales actions, as reported by the Company. As of December 31 2010 the Employee Corporation held 6.09% of the Company's issued capital and 5.81% fully diluted. As of March 15 2011 the Employee Corporation held 29,873,179
4 "The Ginsburg Group" refers to I. Hillel & Co. Ltd., a company fully owned by Mr. Pinchas Ginsburg, a Company director, along with individuals of the Ginsburg family.
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shares constituting 6.03% of the Company's undiluted issued shares and 5.77% of the
Company's capital fully diluted issued capital.
3.5 Table Summarizing Data on Interested Party Holdings The following is a table summarizing a number of facts regarding the Company’s securities and the holdings of the principal interested parties5:
March 15 December 31 December 31 2011 2010 2009 Holdings of interested parties Rate of State holdings in issued capital (undiluted)6 Special State Special State Special State Share Share Share Rate of Knafaim holdings in issued capital 39.33% 39.33% 39.33 (undiluted) Rate of Employee Corporation holdings in issued 6.03% 6.09% 6.25% capital (undiluted) Rate of Ginsburg Group holdings in issued capital 8.74% 8.74% 6.85% (undiluted) Rate of Ms. Tamar Moses-Borowitz’s holdings in 0.41% 0.41% 0.07% issued capital (undiluted) Rate of A.L. Aviation Assets holdings in issued 2.11% 2.24% 1.48% capital (undiluted) Rate of Phoenix Holdings Ltd. holdings in issued 3.84% 2.75% 2.03% capital (undiluted) Rate of Delek Fuel investments and Assets Ltd. 3.60% 3.60% 3.60% holdings in issued capital (undiluted) Rate of Excellence Investments Ltd. holdings in 0.94% 1.03% 1.56% issued capital (undiluted) Company Equity Listed share capital in NIS 550,000,000 550,000,000 550,000,000 (Not including the Special State Share). Issued share capital in NIS 495,719,135 495,719,135 495,719,135 (Not including the Special State Share). Convertible Securities Options to the Chairman of the Company's Board 4,650,000 4,650,000 4,650,000 of Directors, Mr. Amikam Cohen. Options to the Company CEO, Mr. Eliezer Shekedi 9,914,382 9,914,382 ------Options to executives as per the 2006 and 2007 7,772,232 8,935,793 15,244,950 Option Plans 7
5 See Section 9.11.9 below regarding the up to date provisions of the Special State Share. 6 To the best of the Company’s knowledge the State holds 1.1% of the Company’s issued capital. See 1.4 above for details. 7 Less options that have expired and returned to the option reserved for allocation in accordance with the terms of the plan.
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Breakdown of holdings in Company shares. As of December 31 2010:
Breakdown of holdings in Company shares. As of December 31 2010:
Public Delek Group 39% 36% Others Workers Corporation 7% The Ginzburg Group 9% 6% 3% Knafa'im
Breakdown of Holdings in Company Shares As of March 15 2011:
Breakdown of Holdings in Company Shares As of March 15 2011:
Public Delek Group 39% 36% Others Workers Corporation 7% The Ginzburg Group 9% 6% 3% Knafa'im
4. Distributions of Dividends On November 20, 2007, the Company's Board of Directors resolved to update the dividend policy in the aforementioned manner. Within the scope of the new dividend policy, the Company will periodically distribute dividends, at the discretion of the Board of Directors and
subject to the Company's needs. The Company did not distribute dividends in the reported year and during the preceding year.
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On a related note, on March 28, 2005, Knafaim, the controlling owner of the Company, sent a letter to Bank Leumi stating that “considering the present outstanding debt status of El Al with Bank Leumi, and considering the fact that the Board of Directors of El Al is likely to formulate policies from time to time for the distribution of profits of the Company, we state that as long as the balance of the existing principal outstanding debt of El Al to Bank Leumi is no less than $50 million, we will not support a resolution to distribute earnings at a rate which exceeds 60% of the balance of retained earnings of El Al available for distribution as they will exist from time to time, other than after consultation with the Bank regarding the percentage in excess of 60% as stated”. Concurrent with this letter, El Al received a letter from Bank Leumi on March 28, 2005, according to which the bank will not consider the conversion of Knafaim into the controlling shareholder of El Al as an event that entitles the bank to immediate payment of El Al's debt to the bank, conditional upon the terms as detailed in the letter of the bank to the Company, all as detailed in Section 9.8.2.c. below.
5. Financial Information Regarding the Corporation’s Areas of Activity Starting from the first quarter of 2009, the Company has applied in its Financial Statements, changes in its accounting policy deriving from the application of new standards and interpretations of International Financial Reporting Standards (IFRS), which came into effect in 2009, including IFRS 8 "Operating Segments", IAS 1 (Revised) – "Presentation of Financial Statements", IFRIC 13 – "Customer Loyalty Plans" and the revision to IAS 19 – "Employee Benefits", in the framework of the 2008 IFRS improvements. For further details regarding the standards and the impact of their application to the Group's Financial Statements, see Note 3 to the December 31 2010 Financial Statements. Regarding the early adoption of International
Accounting Standard IFRS 9, see Note 3a to the Financial Statements. Details of the Company's business segments in the Financial Statements are given based on the fleets of aircraft – air transport by means of passenger aircraft and air transport by means of
cargo aircraft. The breakdown into business segments selected by the Company as above is in accordance with IFRS-8, according to which the reporting is according to their reports to the corporation's chief business manager. The revenue-producing unit is the aircraft or the family of aircraft bearing similar flight characteristics and not the cargo they carry. The passenger aircraft is comparable to a car capable of carrying a certain amount of cargo, but primarily intended for carrying passengers, while a cargo aircraft is comparable to a container,
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capable of transporting cargo only. Everything located in an aircraft is equally affected by the cost generators (pilots, fuel, capital, air passage fees, parking fees etc.). These factors are a function of the airplane and not of what it carries. In addition, the majority of the operating costs of aircraft carrying cargo in their holds are shared by passengers and cargo – fuel, depreciation, flight crews, air passage fees, communications, landing and parking fees, tarmac and transportation services, security etc. Therefore, the proper business approach is that of the passenger aircraft sector (the holds of which contain a certain amount of space available for cargo) and the cargo aircraft sector. As stated, cargo transport in the holds of passenger aircraft represents part of the operations of passenger aircraft. This activity is auxiliary and a derivative of the operations of transporting passengers in the passenger aircraft and is dependent upon these operations. Thus, for example, the destinations of freight transport in the holds of passenger aircraft are determined by the flight destinations of the passengers in the passenger aircraft. Additionally, the current operations of the Company’s activities as carried out by Company management, including the decision as to the feasibility of the operation of a route and the actual departure of a flight, are carried out based on the above operating segments. Nonetheless, it must be noted that one must look at the profitability of the cargo transport field in a broader context that is derived from the cargo transport operations in the holds of passenger aircraft as well, since the cargo transport field carries out commercial and marketing activities complementary to the activities of the cargo transport activities in the passenger aircraft. Allocation of costs not directly assigned to one of the areas is conducted according to economic models currently existing at the Company. In the future, these costs may be allocated according to other economic models employed by the Company at the time. For details regarding the Company’s reported operating segments see Section a.5 of the Board of Directors Report. The cargo fleet is an independent fleet the economic viability of which is studied separately. For further details see 8.10 below. Note that the 747-200 aircraft used by the Company for the activity in question in the reported year are of a relatively advanced age, which leads to high operating costs, as well as the existence of noise limitations in various airports that affect their operation. For further information regarding the changes in the Company's cargo fleet, see 8.1.2 below. For an analysis of revenues and results by operating segments for 2010, 2009 and 2008 and a presentation of revenues by geographic destinations see Note 37b to the 2010 Financial Statements.
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5.1 Nature of the Adjustments The adjustments of the revenues and costs result from additional activities that are not attributable to the principal areas of activity, primarily maintenance services to other airlines.
5.2 Explanation of Developments Occurring in the Areas of Activity See the clarifications in Section a.3 of the Board of Directors’ Report regarding the explanation of developments in the Company’s operating results during the reporting year compared to last year.
6. General Environment and Effect of External Factors with Regard to the Company
6.1 Movement in the International Aviation Industry The international aviation industry is affected by the economic and security situation and by unusual events, such as the outbreak of epidemics and natural disasters in the world, in general, and in specific areas in particular. The global financial crisis originating from the sub-prime crisis, which began in the second half of 2007 and the impact of which was felt most strongly between Q3 2008 and the first half of 2009, has also had a significant impact on the airline industry. The crisis has led to a significant drop in international passenger traffic, a decrease in business travel and a sharp drop in cargo shipping orders. Starting from the third quarter of 2009, a process has begun of emerging from the economic crisis and economic recovery, mainly in developing Asian markets, which has accelerated the air cargo sector as well as international passenger traffic. Airlines around the world began recovering from the global crisis in 2010: according to IATA data, passenger traffic increased by 8.2% over 2009. Cargo traffic, which reflects the state of global economies, also increased by 20%. Average aircraft capacity was 78.4%, with airlines showing good results this year even compared to the first few months of 2008, before the outbreak of the financial crisis. According to IATA estimates, airline profits in 2010 are expected to reach $16 billion. See 7.1.3 and 8.1.3 below for further details.
6.2 Movement in the Israeli Aviation Industry 2010 was characterized by a calm security situation and economic recovery in Israel and around the world. According to data presented by the Central Bureau of Statistics, 2010 was a record year in terms of Israeli departures and tourist arrivals. 2.39 million inbound tourists via air were listed (including day visits) in 2010, a 16% increase over 2009. In this regard note that the first half of
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2009 was influenced by Operation Cast Lead and by the economic crisis in Israel and around the world, but visitor arrivals in 2010 was 9% higher than even 2008, the previous record year. An increase was also noted in the number of Israelis travelling abroad. 3.59 million departures of Israelis via air were listed in 2010, a 6% increase over 2009, data constituting a 1% increase over 2008. For further details see 7.1.3 below. According to data provided by the Israeli Airports Authority, international passenger movement through BGN increased by 9% in 2010 compared to 2009, which constitutes a 4% increase over 2008. Furthermore, 2010 saw a 10 % increase in cargo traffic to and from Israel in comparison to 2009. See Section 8.1.3 for details.
6.3 Fluctuations in Jet Fuel Prices Jet fuel is a significant component of the Company’s expenses. The jet fuel prices are characterized by extensive and severe fluctuations. The following data refers to jet fuel prices in the Mediterranean Basin region as quoted by Platts8. Over the course of 2010, jet fuel prices fluctuated greatly between a low of 183 cents/gallon listed on February 8 to a high of 248 cents/gallon listed on December 29 2010. In the end, jet fuel market prices increase by an average of 28% in 2010 compared to 2009 prices. See Sections 9.5.1 and 9.18.6 below for further details. See Sections a.3 and b.a.(3) of the Board of Directors' Report for additional details on the financial effect of jet fuel prices, including hedging activity. .
6.4 Foreign Currency Rate Fluctuations The Group’s results are affected by a number of currencies, particularly the U.S. dollar. Fluctuations in the exchange rate of the dollar vis-à-vis other currencies are likely to improve or erode the Group’s profitability. As of December 31 2010, the exchange rate of the U.S. dollar vs. the NIS was revaluated by 6.0% relative to December 31 2009. As of December 31 2010, the exchange rate of the U.S. dollar vs. the euro was revaluated by 8.0% relative to December 31 2009. The change in the exchange rate of the USD vs. the NIS in 2010 negatively affected the Group’s profitability. See Section 9.18.2 below for details.
8 To the best of the Company's knowledge, Platts is a company from the McGraw-Hill Group that has provided information on the energy industry for over 75 years. The company provides updated information and analyses, among other matters regarding prices and international occurrences in the petroleum, petrochemical, natural gas, electric and nuclear power markets
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6.5 Interest Rate Fluctuations The Company took loans in a significant amount at variable interest rates that is based upon LIBOR interest, in order to finance the acquisition of aircraft. A change in the LIBOR interest rate could materially affect the Company’s financing expenses. In 2010, the average LIBOR 3-month interest rate decreased by 49% compared to its average rate in 2009. During 2009, there was a decrease of about 77% relative to its average rate in 2008. See Section 9.18.5 for details.
CHAPTER 3: DESCRIPTION OF THE CORPORATION’S BUSINESS BY AREA OF ACTIVITY
The following is a description of the Group's business for each of its areas of activity separately, with the exception of matters applying to the overall operations of the Group, which are described collectively within the framework of Section 9 below.
7. The Field of Passenger Aircraft
7.1 General Information on the Field of Operations The principal activity of the Group in this area is the transport of passengers on scheduled and charter flights. In addition, the Company carries cargo in the holds of its passenger aircrafts, which is an additional activity to the activity of transporting passengers. This service is additional to other services such as the sale of duty free products to passengers. Accordingly, in the context of describing this field of activity, the Company has focused on the description of transporting passengers. Certain matters that relate to the transportation of cargo in the holds of passenger aircrafts are similar to the service of carrying cargo in cargo aircraft, which is described in Section 8. The following is a description of trends, events and developments in the macroeconomic environment of the Group, which have or are expected to have a material effect on operating results or on developments in the field of activity, in the following areas:
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7.1.1 Structure of the Field of Activity and Changes Occurring Thereof As mentioned, the Company's main field of activity is air transport in passenger aircraft in scheduled flights to and from Israel. By using passenger aircraft, the Company carries both passengers and cargo in the holds of its passenger aircraft. The flight rights under which the State permits one or more “Designated Carriers” to carry passengers on international routes are stipulated in international agreements. Each nation determines an air carrier as a “Designated Carrier” on its behalf to operate the flights and utilize the flight rights. The Company serves as the designated air carrier of the State of Israel on most international routes that operate to and from Israel. See Section 7.1.2 for details on the Company's status as a "Designated Carrier" and State decisions on this issue.
7.1.2 Legislative Restrictions, Regulations and Particular Considerations Applicable to the Area of Activity a. General The main field of activity of carrying passengers and cargo in passenger aircraft is distinguished by international and local regulatory restrictions in various areas. Among other things, authorization is required for operating a flight from one country to another. In accordance with international agreements, each nation is permitted to grant authorization for the operation of scheduled flights (appointment as a “Designated Carrier”) to one airline or to a limited number of airlines, as stipulated in the agreement. The number of Designated Carriers that have been appointed between two destinations is likely to have a material effect on competition between those destinations. The frequency of the flights and the volume of traffic are also conditional on obtaining consents from the aviation authorities in both countries. Additionally, each flight needs a takeoff or landing slot at the airports to or from which it operates. A commercial and operational license is required in order to operate flights, in accordance with Israeli aviation laws. For further information on Israeli aviation laws see 9.11.2 below. In the context of these licenses, the State sets various restrictions on the holder of the license. In the framework of international treaties and agreements and local legislation, arrangements have been made pertaining to operation of the area of activity, which include rules concerning the responsibility of the air carrier for damages caused during the course of international air transport and the responsibility of the air carrier for delays and flight cancellations. Additionally, the Group is committed to operate according to special instructions regarding flight security, which impose additional costs on the Group. In addition, the Group is obligated
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to maintain a minimal fleet of aircraft, in accordance with the Special State Share (also see Section 9.11.9 for details). In addition to scheduled flights, the Company is also engaged in carrying out charter flights by leasing aircraft capacity to organizers of charter flights at prices agreed on in advance and the sale of blocks of seats to agents. For further details see 7.1.10.(c) below.
b. Government Resolution no. 353 on Aviation Policy from 2003 Shortly before publication of the 2003 Prospectus, the Ministerial Committee for Social and Economic Matters decided (decision no. SE/14 dated May 19, 2003) that: (a) The Company would continue to serve as the Designated Carrier on all of the routes on which it served as Designated Carrier immediately prior to publication of the 2003 Prospectus, subject to the following conditions: (1) The Company shall at all times comply with the directives and obligations stipulated for it and which it had assumed vis-à-vis the State of Israel. (2) The Minister of Transportation will consider revoking El Al's status as the Designated Carrier for a specific route if the number of passengers that fly with the Company on that route are 20% or less than the number of passengers that fly on the same route on scheduled flights, or if the number of El Al scheduled flights on that same route are 20% or less than the number of scheduled flights operated by the Designated Carrier of the destination country, during the period of one calendar year. (b). The Ministerial Committee for Social and Economic Affairs also stipulated that the Minister of Transportation will consider whether to grant rights to an additional Designated Carrier for scheduled flights on routes, should the number of passengers flying on the Company's scheduled flights on a specified route be 30% less than the total number of passengers of the scheduled flights on that same route for a period of one calendar year10 9. It was also stipulated that, without detracting from the legal authority of the Minister of Transportation, this policy would be considered if and when the volume of outgoing and incoming air passengers to Israel exceeds 10.7 million passengers annually.
9 The positions of the Deputy Attorney General (Economic-Fiscal) and of the Legal Counsel of the Ministry of Transportation are that Section 2 of the decision is a clear case in which the Minister of Transportation must use his judgment, and according to the fundamental rules of administrative statutes, it does not contain anything that may restrict his judgment or to prevent him from invoking his authority under any law, including in the matter of a Designated Carrier on a scheduled air route, also under other appropriate circumstances. 10 On May 28, 2003, the Director of the Policy Division in the Ministry of Transportation made it clear that the determination of the percentages of the Company's operation, both in Section 1 and in Section 2 of that decision, means “self-operation” by El Al at the rates stipulated and that the aforesaid in no way eliminates the possibility of operating the route by means of a code-share agreement, but then also, the necessary operation is only that carried out by the Company.
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c. Government Resolution 3024 from January 2008 On January 27 2008 the Government passed Resolution 3024, as follows: "a.
(1) To determine the rate of the State's participation in the burden of security expenses of Israeli airlines at the level of 80% of total direct expenses of their operation of existing and future international routes, oriented towards enabling these companies to contend, to the degree possible, in fair and equal competition, opposite foreign airlines and in view of the great importance in the liberalization of the field of civil aviation, while recognizing the need for the existence of strong Israeli aviation.
(2) To revoke Government Resolution No. 2325 from July 30 2002.
b. To determine that the rate of participation mentioned in a. above is a continuation to the resolution of the relevant institutions in "El Al" Israel Airlines Ltd. ("El Al"), which recognizes, to the Company's favor, the importance of raising the percentage of the State's participation in the burden of security expenses of Israeli airlines, and accordingly, to change the Government's aviation policy on the scheduled routes, as provided in Section c. below.
c. To amend Government Resolution No. 353(KM/14) dated June 5 2003 regarding the aviation policy of the State of Israel on scheduled routes as follows:
(1) Instead of Section 1(b) of the Resolution, the following shall appear:
(b) "The Minister of Transportation and Road Safety, within the scope of his jurisdiction regarding aviation policy, as authorized by law, shall consider whether to grant rights to an additional Designated Carrier on scheduled air routes, and will consider whether to revoke El Al's status as a Designated Carrier on a specific route".
(2) Sections 2-3 of the resolution shall be revoked.
d. To impose on the Minister of Transportation and Road Safety to form an inter- ministerial team with the participation of representatives of the Ministries of Transport and Road Safety, Treasury and the General Security Service, to assess ways to implement the security instructions for Israeli civil aviation.
Date of implementation – as specified in the Resolution."
d. Implementation of Government Resolution 3024 Government Resolution 3024, as denoted above (hereinafter in this subparagraph: "Resolution 3024" or "the Government Resolution") regarding the increase in Government participation on security expenses of Israeli airlines while amending the 2003 government resolution regarding El Al's status as Designated Carrier mainly consists of two interrelated parts: (a) establishing the State's share of the airlines' security burden at 80%; (b) amending the aviation policy of the
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State of Israel for regular routes, as determined in the May 2003 Government resolution, by revoking various threshold demands, which require that the Minister of Transportation and Road Safety ("the Minister of Transportation") consider whether the Company's status as Designated Carrier on a regular route be revoked or a Designated Carrier be added to a certain route in addition to the Company. In practice, Resolution 3024 was only partially implemented, in such a manner so that a. above was not implemented while b. was, as detailed in 9.11.7.2 below.
As a result of the failure to implement both parts of the decision concurrently, in a manner contrary, according to the Company's arguments, to the letter and spirit of the Government Resolution, and as the Company's queries to the Ministry of Transportation and the Ministry of Finance on the matter of the implementation of both portions of the Government Resolution received no response, the Company filed a petition against the Government of Israel, the Minister of Finance, the Minister of Transportation and other respondents ("the Petition") before the Supreme Court, sitting as the High Court of Justice, on May 27 2008.
As part of the Petition the Company requested, inter alia, that a temporary injunction be issued against the respondents instructing them to give cause as to why the Resolution 3024 has not been implemented immediately and in full. The Company also requested that a injunction be issued preventing the respondents from implementing and/or from continuing to implement Resolution 3024 in a partial manner only, meaning to avoid implementing only that portion of the Resolution dealing in the appointment of additional Designated Carriers, this until the Petition is resolved.
e. Government Resolution 4032 from August 2008 On August 24, 2008, Government Resolution no. 4032 was passed on the subject of the state's participation in Israeli airline security expenses, as follows: "
1. To revoke Government Resolution no. 3024 dated January 27 2008 (hereinafter "the Resolution") starting January 1 2009 or on the date on which the scope of passengers entering and exiting Israel by air is greater than 10.7 million passengers per year, whichever is later. 2. Section A of the Decision shall be implemented until its cancellation as stated in Section 1 of this decision, only on flight routes for which an additional listed Israeli carrier has been actively appointed, which has started to operate on the flight route. 3. To authorize the Ministries of Finance and Transportation and Road Safety to increase the state's participation rate in security costs for Israeli airlines, pursuant to the signing of a global aviation agreement with the EU in accordance with Government Resolution no. 441 dated September 12 2006. 4. The budgetary expense of Government Resolution 3024, until its cancellation as denoted in Section 1, shall be financed from the Ministry of Transportation's existing budget."
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On September 11, 2008 the State of Israel, the Minister of Finance, the Deputy Prime Minister and the Minister of Transportation and Road Safety field a preliminary response to the aforementioned Petition (the "State's Response"). As stated in the State's Response, in light of the passing of Resolution 4032 (the "Cancellation Decision"), which alters and limits the incidence of Government Resolution 3024 dated January 27 2008 (the "Original Decision"), the Cancellation Decision significantly alters the grounds upon which the Petition is based and therefore the Court is asked to reject it. On September 18 2008 the Company filed a request to amend the petition (the "Petition Amendment Request"), this in light of the State's response, so that in the framework of the Amended Petition, the Company will ask the Court to issue an order to the respondents, according to which they must provide cause as to why the Cancellation Resolution should not be revoked leaving the Original Resolution - the application of which has already begun - in effect, to be applied by the Government in full, and alternately, if the Cancellation Resolution is to remain in effect, why the situation should not be returned to its previous state prior to the original resolution, including the cancellation of the appointment of other Israeli airlines as Designated Carriers, which was made as a result of the original resolution. Accordingly, a revised petition was filed on December 23 2008.
f. Government Resolution 4462 from February 2009 On February 1 2009 the Israeli Government passed an updated resolution regarding participation in the security expenses of Israeli airlines (following the resolutions dated January 27 2008 and August 24 2008), as follows: "
a. To increase the participation rate in security expenses in Israeli airlines to 60% from 2009 onward. Implementation of the resolution shall take place immediately following the Knesset approval of the 2009 budget. b. To instruct the Ministers of Finance and Transportation and Road Safety to increase the State's participation in Israeli airline security costs to 75%, immediately after the signing of a global aviation agreement with the European Union ("Open Skies") in accordance with Government Resolution 441 dated September 12 2006. c. To instruct the Minister of Transportation and Road Safety to report to the Government, six months subsequent to this resolution, on the progress of the negotiations with the European Union regarding the global aviation agreement ("Open Skies"). d. Prior to the approval of the 2009 budget, the Budget Controller at the Ministry of Finance will act to submit a budget addition deriving from this resolution for the Government's approval, for the funding on an increase in the State's participation in civil aviation security costs. e. The airlines will act to conduct "exchange purchases" in Israel, as much as is possible at rates agreed upon with the Industrial Cooperation Authority."
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Note that a hearing has been set for the petition in question for July 2011. The implementation in full of the Government Resolutions and their potential impact on the Company's activities and operating results constitute Forward-Looking Information as defined in the Securities Law. The manner and degree to which the Government Resolutions are actually implemented, the receipt of security expenses funding at the updated rate and the appointment of additional Israeli airlines as Designated Carriers for scheduled flights and the operating of said flights by additional Israeli airlines may be conducted differently than estimated, among other things due to regulatory limitations, economic limitations resulting from the need to purchase equipment needed to operate additional airlines, contractual limitations involved in the alteration of bilateral agreements or other aviation agreements as well as changes in the national security, economic and geopolitical information and their
impact on competition as well as changes in Government resolutions.
7.1.3 Changes in the Volume of Activity and Profitability of the Area
(a) International Developments
According to IATA estimates, international passenger traffic increased 8.2% in 2010 and international cargo traffic (including in the holds of passenger aircraft) increased by 20.6%. The growth in passenger and cargo traffic was higher than the rate of growth listed in the seat capacity offered in passenger flights (4.4%) and the 8.9% increase in available ton-kilometers. Therefore, the weighted load factor in international flights was 78.4% compared to 75.7% in 2009 and the weighted load factor in cargo flights was 53.8% compared to 48.6% in 2009.
In December 2010 IATA published a new evaluation, according to which expected airline profits in 2010 would amount to $15.1 billion (exceeding IATA projections from 2009, which predicted a profit of $8.9 billion), this in light of the exceptional achievements noted by airlines in Q3 2010. The airlines increased their seat usage in order to provide a response to the increase in demand, but at the same time, the airlines maintained stability in their fixed costs, increased their average yield per passenger and their profits. In March 2011 IATA corrected its estimate regarding profits expected for airlines in 2010. According to the revised IATA estimate, airlines are expected to earn $16 billion in 2010.
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By Regional Cross-Section - 2010 versus 2009:
Passengers Cargo RPK ASK PLF FTK AFTK Area Annual Annual Annual Annual change change change change Africa 12.9% 9.6% 69.1 23.8% 12.1% Asia 9.0% 3.6% 77.6 24.0% 14.3% Europe 5.1% 2.6% 79.4 10.8% 0.5% South 8.2% 2.9% 76.7 29.1% 12.6% America Middle East 17.8% 13.2% 76 26.7% 15.7% North America 7.4% 3.9% 82.2 21.8% 6.1% Total 8.2% 4.4% 78.4 20.6% 8.9%
Asian airlines listed a 9% increase in passenger traffic in 2010 compared to 2009, with China and India continuing to serve as the growth engine for the region’s recovery.
European airlines listed a 5.1% increase in passenger traffic, twice the rate of the increase (2.6%) in their supply of seats, which led to an increase in their load factors (79.4% compared to 76.4 in 2009). At the same time, the economic uncertainty and the continuing euro crisis reduced the improvement in the yields of airlines in the region.
North American airlines increased their passenger traffic by 7.4% in 2010 by careful management of the offered seat capacity (increasing seat supply by just 3.9% led to an increase in load factor to 82.2% compared to 79.6% in 2009), this as a result of the significant increase in yields and profits of airlines in this region.
Middle Eastern airlines listed the highest levels of growth, a 17.8% increase in passenger traffic and a 13.2% increase in seat capacity, which was accelerated upon the delivery of new aircraft to Persian Gulf airlines. The load factor on passenger flights increased slightly to 76%.
South American airlines listed an 8.2% yearly increase in passenger traffic (an 8% increase over 2008).
African airlines listed a 12.9% increase in passenger traffic in 2010, but at the same time the average load factor of airlines in the region was 69.1%, lower than the industry average.
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IATA projects that despite the slowdown expected in the recovery in passenger and cargo traffic, the international aviation industry will continue to show profits in 2011. In March 2011 IATA revised its projection in light of the political instability in the Middle East and the events occurring in Tunisia, Egypt, Libya and Bahrain, which brought about a drastic increase in fuel prices (over $100). According to updated IATA projections published March 2011, airlines are expected to gain $8.6 billion in 2011, this compared to projected gains of $9.1 billion as per the projection published December 2011. According to the projection, the profit expected for airlines in 2011 is 46% lower than airline profits in 2010 and represents a net profit of just 1.4% of the airline’s total revenues, which are expected to reach $594 billion.
The following are the key points of IATA’s 2011 projections:
Fuel – IATA raised its projection for the average price of a barrel of oil to $96 per barrel in 2011(Brent price) compared to a projection of $84 per barrel made in December 2010. This change is expected to lead to an increase in airline fuel costs, which are expected to total $166 billion. Fuel costs in 2011 are expected to be 20% higher than 2010 and constitute 29% of operating costs (compared to 26% in 2010). The expected increase in airline revenues will not fully compensate for the increase in manufacturing costs (fuel).
Increase in demand – the global growth rate (GDP) is expected to reach 3.1% in 2011 (compared to a projection of 2.6% in December 2010). Accordingly, IATA revised its projections for passenger and cargo traffic projection, which are expected to increase by 5.6% and 6.1% respectively in 2011 (compared to a 5.2% and 5.5% increase, respectively, in IATA projections from December 2010). In total, a 5.7% increase is projected in flown tons/kilometer (both passengers and cargo).
Increase in capacity – published airline schedules indicate a 6% increase in capacity. 5% of the increase comes as a result of 1,400 new aircraft joining airline fleets and 1% comes as a result of the normalization of wide-body aircraft capacity.
Yields – the expected gap between the increase in demand (5.7%) and the increase in capacity (6%) is just 0.3%, compared to a 0.8% gap in the December 2010 projections. Closing the gap between supply and demand allows airlines to improve their yields. The yield per passenger is expected to increase by 1.5% (compared to a 0.5% increase in the previous projection) and the yield per ton of cargo is expected to increase by 1.9%
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(compared to the previous IATA projection from December 2010, which expected no changes in yield per ton of cargo).
Premium traffic – premium traffic (prestige classes) constitutes an important component of airline profits. The economic recovery and the increase in global trade also motivate business traffic, albeit at a lower rate than in 2010.
Threats – oil prices are the largest threat to the aviation industry, with rising prices capable of leading to additional drops in airline profitability. IATA has noted the threat presented by the expected increase in taxation, which may have a particular impact on the vacation traffic segment, which is price-sensitive. Over the course of 2010 taxes increased in several European airlines (the UK, Austria and Germany), and plans have recently been presented to increase taxes in other countries as well.
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The following table shows the activity of the international aviation industry (scheduled flights) over the past four years as well as the industry's revenues and earnings throughout the period.
International operations of the aviation industry and its profitability from the passenger aircraft segment 11 (scheduled flights) of airlines belonging to IATA:
Year Output Operational Operating Profit (Loss)
Revenues 12 (in (in Billions of Dollars) Billions of Dollars) RPK14 (in Annual RTK13 (in Annual Before After Millions) Change in Millions) Change in Interest Interest RPK RTK Expenses Expenses
201015 8.2% 16.0
2009 2,373,750 -2.9% 289,213 -2.2% 239,1 -2.7 -5.2
2008 2,436,045 2.4% 295,783 1.3% 275.6 2.9 1.0
2007 2,365,964 7.7% 292,247 6% 255.4 9.0 7.1
2006 2,230,135 6.1% 275,949 5% 232.8 6.1 4.1
(b) Developments in the Israeli market
International passenger traffic to/from BGN in 2010 totaled, according to Airport Authority data, approximately 11.4 million passengers, a 9% increase over 2009 and 4% over 2008, the previous peak year in terms of tourists entries and Israeli tourist departures.
11 The source of the data regarding 2005-2010: IATA publications (World Air Transport Statistics) (WATS; 54th Edition-2010). 12 Including cargo aircraft revenues. 13 Revenue Passenger Kilometer - the number of paid pass passengers multiplied by the distance flown. 14 Revenue Ton Kilometer - the weight in tons of passengers and paid cargo multiplied by the distance flown. 15 IATA data, estimates, assessments and projections referring to 2010 are preliminary. Final 2010 data is expected to be published by IATA in June 2011 within the framework of World Air Traffic Statistics.
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Passenger Traffic to and from Israel (to/from BGN)16
Year Passenger Traffic Through BGN
(Millions of Passenger Legs) Yearly Change
2010 11.4 9%
2009 10.5 -5%
2008 11.0 10%
2007 10.1 15%
2006 8.8 4%
The table and the graph below reflect the trends of incoming tourist traffic to Israel and the departing residents in recent years via air 17
Year Incoming Tourists (Foreign Passports) Departing Residents
(In Thousands of Rate of (In Thousands of Rate of Passengers) change Passengers) change 2010 2,386 16.4% 3,591 5.7%
2009 2,049 (6.4)% 3,397 (4.4)%
2008 2,190 22.0% 3,552 3.5%
2007 1,790 14.2% 3,433 9.2%
2006 1,565 (5.1)% 3,145 4.4%
According to Company estimates, tourist traffic to Israel is influenced by international passenger traffic trends, the economic situation and mainly by geopolitical processes in Israel or the region, which have affected the security felt by tourists to the region.
Note that in 2010 the decrease in Israeli traffic to Turkish resort sites continued in light of the continuing tension between the countries since Operation Cast Lead in 2009, which intensified after the Turkish Gaza flotilla events in late May 2010. At the same time, the flotilla event did not impact incoming tourist traffic to Israel and/or the scope of departing Israeli traffic.
16 Source: Civil Aviation Administration (including non-paying passengers). In addition to the traffic to BGN, tourists in regular and charter flights arrive in Israel through the Eilat airport in minimal numbers compared to the traffic at BGN. The term “leg” means a flight section from destination to destination. 17 Data from the Central Bureau of Statistics.
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The IATA forecasts and estimates regarding the volume of passenger traffic to and from Israel as above represent forward-looking information, as defined in the Securities Law. This information is supported, inter alia, by the Company’s assessments in light of the trends of change in tourism during recent years and expected developments, and in view of the economic, security and geopolitical situation in Israel. Accordingly, the actual change in the anticipated volume of incoming tourists to Israel and the outgoing tourism from Israel may be materially different from that forecast as aforementioned, if the Company's assessments are not realized, and because of a large number of factors, including a change in economic, security and geopolitical conditions in Israel.
7.1.4 Developments in the markets of the field of activity or changes in the characteristics of its customers: In recent years, competition has intensified considerably in the passenger aircraft transport field between dozens of international scheduled and charter airlines. The airlines compete in various areas, principally fares, frequency and flight times, punctuality, equipment type, airplane configuration and passenger service. Fare competition is reflected primarily by offering reduced rates to passengers. The competition is present both in relation to direct scheduled flights between various destinations and with charter flights to the same destinations. In addition, in this context, there has been an increase in the activities of the foreign airlines in Israel in the framework of Sixth Freedom. Furthermore, during recent years, airlines known as “low cost airlines”18have entered the aviation world, maintaining low expenses and generally offering very competitive prices. For further details see 7.1.10.(d)
below. The increase in the number of foreign airlines operating out of BGN, in the number of scheduled flights and in the seat capacity of the foreign airlines, led to a further increase in the level of competition on routes to and from Israel, and the Group’s market share in passenger traffic through BGN was 37.1% compared to 37.5% in 2009. See Sections 7.1.10 and 9.11.7.2 below for further details. For details regarding the implementation of the Ministry of Transportation's liberalization policy
and the appointment of Israeli airlines as Designated Carriers see Section 7.1.2 above.
18 "Low cost" airlines are relatively new airlines with a structure of low expenses deriving mainly from direct marketing through the Internet and not through distribution systems and travel agents. Characterized by use of secondary airports, minimal service profile during the flight and operations on short range flights, with no code sharing agreements with other companies and high utilization of aircraft.
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7.1.5 Technological Changes that could Materially Affect the Area of Activity As part of the development and establishment of direct Company distribution and marketing channels, growth in the direct online marketing of flight tickets continued to increase in such a manner that the Company's total online sales amounted to $98 million in 2010 (a 31% increase over online sales in 2009). The Company’s new website was launched in early March 2011. The site is expected to undergo changes over the course of 2011 involving the receipt of advanced and innovative design while expanding its various functions, in order to become more accessible and easy for customers as well as to create a friendly interface for frequent flyer club members visiting the site. The Company is acting to significantly expand its online trading capabilities, including by translating its website to additional languages, expanding its overseas clearing and sales options and developing sales possibilities through additional channels other than credit cards. Additionally, online collaboration was expanded, including travel insurance sales options as part of the reservation site (see 7.4 below for details) and collaborations with leading sites. In March 2011 the Company launched the El Al legacy site. The site contains stories, images and films documenting the Company's 63 years of history. Starting from Q4 2010 the Company began providing a new service on the site, an internet chat service that provides an immediate response to customer needs, if customers are interested in help of information from the site, the chat service directs them to a service operator sitting in front of a computer with access to various internet services who provides the customer with an immediate response on a variety of issues including information regarding flight tickets, questions regarding existing deals and so on. In addition, the Company has launched a new development allowing travel agents to see ticket details on their computer screens, print them out and send them by email. Travel agents wishing to view a flight ticket will be asked to use their IATA number or order code. Until now, reservation ticketing took place at agent service centers and the new system allows transparency, contributes to agent independence and improves passenger service. A designated iPhone app was launched in 2010 for checking in by Company representative at Ben Gurion airport. Later on, the application was launched at Apple’s international store and as of a date immediately prior to the report has been installed by over 5,000 customers. In addition, an existing app was purchased allowing customers to check out takeoff and landing times on their iPhones. Starting January 2010, the Company has been operating a CO2 emission monitoring and tracking system on Company aircraft in order to comply with EU guidelines. The system
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collects data from various sources (both from the ground and from Company aircraft) and concentrates it into a single database, and features a tool for controlling and analyzing this data. A new flight planning system entered service at the Company’s control center in late June 2010. The system plans optimal flight routes, taking into account all required parameters such as various costs, flight distances and amounts of fuel required. The system is interactive, interfaces with other Company systems and allows an extremely high level of precision. The system is expected to save fuel costs and transit commissions. On June 1 2010 the Company joined the IATA clearing program, the BSP (Billing & Settlement Plan). This shift to the world’s most widely-used payment system constitutes a technological innovation and was designed to streamline and simplify the sales, reporting and accounting process for airline companies in dealing with travel agents. Additionally, it allows better control and supervision of airline cash flows. As part of the constant effort to improve service processes, a new system was placed at the entrance to the Company’s BGN lounge. Using the system, customers staying at the lounge are identified and personalized customer services can be offered. The Company completed the transition of its DCS screening system (DCS) to the Amadeus system in stations in Israel and around the world. Alongside the system's implementation, the online check-in system was improved, allowing self-check-in with the new system. This step constitutes a comprehensive solution for sales and for customer reception processes at the airport. As a result, use of the Carmel system was discontinued. The Company is acting diligently to improve service and permit safe purchasing at the Company website. For this purpose, an online fraud examination system was applied, which collects and analyzes various data before allowing customers to make purchases through the site. The system significantly reduces fares and contributes to online customer security, benefiting the Company and its customers. Likewise, credit card verification by VBV (Verified by Visa) was integrated. The Company is highly compatible with PCI standards. In addition, in order to provide a response to customer afraid to divulge their credit card information online, a global interface was developed with PayPal, which specializes in providing online payment solutions allowing any customer with an email address to pay for their tickets on the site without revealing their credit card data through their PayPal account in any country in which such an account exists.
Following that stated in the 2010 quarterly reports regarding the cancellation of the agreement to carry out the ERP project, the Company has begun the process of receiving new proposals
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from various bodies (RFP) for the implementation of a staged ERP project for select Company organizational units in Israel and around the world. The process of selecting the implementing party has yet to be completed. The Company is currently in advanced stages of finding a solution for maintenance and engineering (M$E) components, which shall be integrated in the move which includes a single integrative system. For further details see Note 17c to the December 31 2010 Financial Statements.
The Company is currently in the process of establishing a backup site for the Company’s ITS and communications systems. The site was designed to constitute a response to possible environmental failure situations such as fires, flooding and so on. The site is expected to provide a backup response to systems defined as critical for the Company’s business and operational activity.
In order to streamline and improve work processes with agents and customers contacting the customer service department, in January 2011 the Company issued a request for proposals for
the characterization and establishment of a CRM system for a closed group of suppliers. The system shall be characterized and developed out of the view of the system as an infrastructure
for broad CRM applications at all of the Company’s service locations.
The Company recently approached a number of potential candidates as part of the proposal process (ARFP) for the replacement of the existing revenue management system (RMS), including associated system, as well for the establishment of a new pricing system. The proposals received are currently undergoing review. The Company recently approached a number of potential candidates as part of the proposal process (ARFP) for the replacement of the existing cargo activity management systems; the proposals received are currently undergoing review.
The information on the implementation and characterization of the above systems, including project completion dates and their impacts constitute forward-looking information, as defined in the Securities Law. The actual implementation of these projects, their dates, their scopes and their impact on the Company's could be materially different from that forecast, due to reasons including technological, commercial and service-related reasons and as a result of the Company's ability to accept the system and the resources allocated for this purpose.
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In recent years, the aviation market has geared up to deal with terror events by expanding the use of advanced technological and other means, on land and in the air. Within the scope of these preparations, the Company is working in accordance with the instructions of the General Security Service, inter alia, for evaluating and installing protective measures. For further details on security arrangements see Section 9.11.12 below.
7.1.6 Critical Success Factors ion the Area of Activity and Changes Occurring Thereof A number of factors can be pointed to in the operations of the passenger and cargo transport area via passenger aircraft, which affect the competitive position in the field: the economic and security situation in Israel, which influences passenger traffic to and from Israel; the branding of the Company in the eyes of the customers, including in matters of safety and quality of service; the ability to offer flights to popular destinations at competitive prices and development of a network of routes independently and in cooperation with other airlines; preservation of aviation rights; the ability to offer flights at the frequency and the capacity demanded; a distribution system; risk management by implementing appropriate risk hedging policies.
7.1.7 Changes in the Supplier Network and the Raw Materials for the Field of Operations The primary raw material consumer by airlines is jet fuel and it represents one of an airline's major expense components. See Section 9.5.1 below for details relating to fuel.
7.1.8 Main Entry and Exit Barriers of the Field of operations and Changes Therein One of the most significant entry barriers in the area of the international scheduled flights is obtaining the authorization to carry out scheduled flights from one country to another. In accordance with international agreements, each country is permitted to grant such authorization (appointment as “Designated Carrier”) to carry out flights from that country to other countries to one airlines or to a limited number of airlines, as stipulated by agreement. The more liberal the aviation agreement between the countries, the lower the entry barrier. For Government resolutions on Designated Carriers and developments deriving from this decision, see 7.1.2 above. In addition to obtaining authorization from the airline's parent country, consent is generally required from the countries to which the airlines wishes to fly with relation to the number of flights and to the capacity of the flight. In addition, each flight must have a slot with regard to takeoffs or landings at the airports to or from which it operates. See Section 8.1.8 and Section 9.11.7 below for details. The most important additional entry barrier is the initial relatively large
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investment that is necessary in order to establish and operate an airline, including aircraft purchasing or leasing.
Under the international aviation agreements, obtaining appointment as Designated Carrier is conditional upon the substantial ownership and effective control of the air carrier being in the hands of the state or citizens of the country that has specified that it be the Designated Carrier. This requirement represents an entry barrier for obtaining the appointment as Designated Carrier by companies the majority ownership and control of which is held by foreign citizens. However, within the framework of the liberalization of the aviation industry, over the course of the past few years the bilateral agreements between the State of Israel and other nations have been revised in such a manner so as to allow the appointment of a Designated Carrier the principle place of business of which is located in the territory of the side appointing the carrier and that the carrier holds an air operator's certificate issued by the appointing side (as in the agreements with the U.K., France and others). As part of the "horizontal" agreement signed between Israel and the EU in December 2008, it was agreed to grant authorizations to European airlines to fly to Israel from any country in the EU, even if it is not the airline's parent country, with the only limitation being that the number of the flights from the third country be no greater than the sum of the flights allowed from that country in accordance with the aviation agreement between it and Israel. With this, the ownership and control limitation was in effect removed as a condition for receiving the Designated Carrier status. For details regarding the "open skies" agreement with the EU see Section 7.1.10.b.(3) below. As regards the operation of passenger aircraft in international charter flights, each Israeli carrier must obtain a license to operate charter flights to and from Israel, which is subject to various demands, mainly: economic stability and ownership or leasing of at least two aircraft. Additionally, each Israeli carrier and foreign carrier must obtain authorizations for charter flights from the Civil Aviation Authority. At present, a more liberal policy of granting authorizations in the area of charter flights is in effect, both with relation to Israeli charter airlines as well as with relation to foreign charter companies. Therefore, in the Company’s estimation, there are no material entry barriers in the field of charter flights. In addition to the above, various licenses and permits are required to conduct activity. For further details see Section 9.11 above.
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The restrictions placed on the Company by the holder of the Special State Share in the matter of the reduction of the Company's aircraft fleet constitute an exit barrier. See Section 9.11.1 below
for further details.
7.1.9 Substitutes for Services of the Field of Operations and Changes that have Occurred Therein The alternatives for transport in passenger aircraft are transport by other means (maritime and surface vehicles and cargo aircraft for cargo in the holds of passenger aircraft). Note that Israel has no significant alternative to air passenger transport. In addition, the Group has competitors that offer alternative transport in passenger aircraft in scheduled flights, charter flights and low cost flights. There were no substantial changes during 2010 in alternatives to transport by means of passenger aircraft. In the Company's estimation, the major considerations in preferring flight to sea and/or land transport are purpose of travel, traveler's timetable, the distance and the nature of the route.
7.1.10 Structure of Competition in the Field of Operations and Changes that have Occurred Therein a) General There is severe competition in the passenger aircraft transport field between dozens of international scheduled and charter airlines. The airlines compete in various areas, principally: fares, frequencies and flight times, punctuality, equipment type, airplane configuration, passenger service, bonuses to frequent travelers, commissions and special incentives to travel agents and supply of computerized reservation and distribution systems to travel agents. Fare competition is reflected mainly in the offering of cheaper fares to passengers or special rates to cargo shippers. The competition is not only with the Designated Carrier of the country that is located on the other end of the route and with charter airlines that operate on the same route, but also with other airlines, including those not operating flights to Israel (offline airlines), this as the result of the travelers' diverse alternatives in arranging their own flight schedule, in which a number of airlines participate, and the strengthening of code sharing agreements between airlines (Star, Sky Team, One World) Additionally, most of the scheduled airlines operating flights to and from Israel also carry passengers on Sixth Freedom Flights. Because the flight from the home airport (Europe) to the United States is carried out without any connection to the flight from Israel to Europe, the
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situation sometimes permits the foreign company to lower the total price for the flight from Israel to the United States (through Europe) without reducing the price at which the airline ticket from Europe to the United States is sold. As a matter of fact, sometimes the foreign airlines offer the airline ticket from Israel to the final destination (the United States, for example) at a price lower than the price which they offer for the flight from the stopover destination (Europe, for example) to the final destination. On the other hand, the Company does not presently enjoy the similar ability to transport passengers between different countries via Israel, primarily because of the current geopolitical situation. A significant portion of the aviation agreements between Israel and other nations state that the offered capacity must be based on the volume of the traffic between Israel and the other nation with which the agreement was signed. In recent years the Ministry of Transportation has began implementing a policy of increasing liberalization in the field of aviation, with the goal of encouraging and increasing the volume of tourism to Israel by increasing competition between airlines, which is expressed in increased capacity and added frequencies by foreign airlines operating in Israel. Likewise, over recent years, aviation discussions were held with the civil aviation authorities of several countries and new agreements were signed, in which the liberalization policy in the air transport field was expressed, in such a manner that the agreements established multiple Designated Carriers, enabling an increase in the number of airlines that can operate scheduled flights on the routes to and from Israel as well as increasing their frequency (see below for details on the agreements and resulting developments).
b) "Open Skies" Policy The Public Commission for Examining the "Open Skies" Issue The report the key points of the report and recommendations of the public commission for evaluating the "Open Skies" issue on April 16 2007. According to the commission's report, the State of Israel is striving to adopt an aviation policy that will serve as a springboard for economic growth and increased tourism to and from Israel, based on the importance of a national aviation industry that will take part in equal and fair competition, based on the global environmental conditions and transforming the State of Israel, from an aviation standpoint, to a more attractive destination than its competitors, in terms of price and in terms of capacity of the airlines over time. The report further stated that opening the skies will bring with it the entry of new operators, a decrease in fares and an increase in the State of Israel's exposure as a competitive destination
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and consequently, an increase in the number of tourist arriving via air. At the same time, the policy will also apply to Israeli passengers, who will benefit from falling prices and the more diverse range of services and destinations.
Implementation of the Open Skies Policy The following is a description of the main changes deriving from the Ministry of Transportation's Open Skies policy in 2010: Open Skies Agreement between Israel and the U.S. – a new aviation agreement was signed between Israel and the U.S. in December 2010. The new agreement is expected to expand the previous agreement, and will come into effect only after the FAA restores Israeli civil aviation safety to Category 1 rating. The new agreement, like the previous one, does not limit the number of airlines allowed to fly between the U.S. and Israel. The importance of the new agreement is that it will also allow the signing of code sharing agreements with third countries on routes between Israel and the U.S. In addition, the new agreement will not limit the number of U.S. destinations Israeli airlines are allowed to arrive at to. Also note that United Airlines and Continental Airlines have merged into the world's largest airline. The merger is also expected to impact the Israeli aviation market and lead to intensifying competition on direct U.S. routes, after the merged airlines begin operating flights from other destinations.
Greece – In October 2010 Israel and Greece signed a new aviation agreement allowing additional Israeli and Greek airlines to operate direct flights between the nations. The new agreement will allow each country to appoint two airlines to operate scheduled flights on each route between Israel and Greece and operate up to 28 weekly flights on the Tel Aviv-Athens route (14 per side), compared to a total of 14 weekly flights operated to date. In addition, the agreement was expanded to additional Greek destinations and an agreement was reached to operate 14 weekly cargo flights between the countries. As noted, in January 2010 Greek airline Aegean Airlines, which had one a tender to operate the Tel-Aviv-Athens route, replaced Olympic Airlines, which had operated scheduled flights on that route until that date. Both Greek airlines have recently begun talks regarding the possibility of a merger. Ukraine – following the new aviation agreement signed between Israel and Ukraine in February 2010, allowing the appointment of a third designated carrier for the Tel Aviv-Kiev route by each sides, starting May 2010 Ukrainian National Airlines began gradually operating five weekly flights on the Kiev-Tel-Aviv route. This airline joined Aerosvit and DonbassAero,
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which operated on this route until July 2010. Note also that in July 2010 Israel and Ukraine signed an agreement cancelling the need for visas between Israel and Ukraine, which came into effect in February 2011 and according to Ministry of Tourism estimates may lead to a significant increase in passenger traffic between the two countries starting April 2011. Following the signing of the agreement, Ukrainian airline Aerosvit announced that it intended to increase the number of flights it operates on routes between Israel and Ukraine starting April 2011. According to its announcement, Aerosvit is expected to operate 20 weekly flights on the route (compared to 16 today) – 13 flights to Kiev, 2 additional weekly flights to each of the following destinations: Odessa, Simferopol and Dnepropetrovsk as well as a single weekly flight to Donetsk. On the Israeli side, the Minister of Transportation permitted Israir to operate scheduled flights on the Kiev-Tel-Aviv route in addition to the Company and Arkia. Israir has yet to begin operating this route. In addition, Arkia was permitted to operate scheduled flights between Eilat and Kiev. Note that Arkia, which operates 2-3 weekly flights on the Tel Aviv-Kiev route and discontinued their activity during the winter season, began re-operating 2 weekly flights on the route starting March 2011. Russia - in August 2010 Russian airline Aeroflot began operating 5 weekly flights on the Tel Aviv-Moscow route. In this regard note that in December 2010, Aerroflot received immediate approval to operate 8 weekly flights on the Tel Aviv-Moscow route as well as approval to operate 5 weekly flights on the Eilat-Moscow route, instead of the current 4, starting from the summer 2011 timetable. Aeroflot announced that starting from April it would operate 2 additional frequencies on the Tel Aviv-Moscow route and in total would operate 7 weekly flights. In October 2010 Israir began operating two regular weekly flights on the Moscow-Eilat route, which shall be operated until the end of the winter vacation period in May 2011. These flights will be in addition to the 4 weekly Israir flights from BGN to Moscow. In addition, in March 2011 Arkia began operating 2 weekly flights on the on the Tel Aviv- Moscow route in a low-cost format. Belarus – Sun D'Or began operating scheduled flights to Minsk starting June 2010, following its appointment as designate carrier for this route. Additionally, the Ministry of Transportation granted permission to Sun D'Or to operate direct flights to Riga (Latvia) instead of Israir, which had failed to make use of its right to operate scheduled flights on this route as well as to Lisbon (Portugal) and Almaty (Kazakhstan)
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Romania - Israel and Romania have signed a new aviation agreement, according to which each of the designated carriers - El Al on the Israeli side and TAROM on the Rumanian side – would be able to operate up to 14 weekly flights to destinations between the two countries with no commercial or capacity limitations. In addition, each country may appoint an additional airline to carry out up to 7 passenger flights to each destination between Romania and Israel, with no commercial or capacity restrictions. Jordan – Israel and Jordan signed a new aviation agreement allowing both countries’ airlines to increase their weekly seat capacity on the Tel Aviv-Amman route by 50% to up to 1,500 seats, instead of the current 1,000 seats. In addition, the frequency limitation between Israeli and Jordanian airlines, at 14 weekly flights per party was completely revoked, and it was agreed that no limitations would exist on the number of weekly flights between the two states. For the first time, the agreement established the possibility of operating scheduled flights from Aqaba and Eilat at with no restrictions on frequencies, capacities or airlines. Pursuant to the talks, the subject of management of air traffic in the regional sector was also discussed and revisions were begun to the letter of consent between the aviation authorities of both countries signed in 1995, following the signing of the peace agreement between Israel and Jordan. The revision to the letter of consent was intended to set in writing the progress and development occurring in recent years in aviation procedures and technologies used to manage air traffic. The revision will allow the streamlining if the use of the both countries’ airspace and increase the level of civil aviations security in the region. Georgia – over the course of October 2010, Israel and Georgia agreed to increase the flight frequencies approved for either country from the current 6 to 10 weekly flights by each side. It was also agreed that each county would be allowed to appoint three scheduled airlines to operate passenger flights instead of the current single airline per side. As a result, both countries' aviation authorities are expected to sign a new aviation agreement soon, which will allow an increase in the number of frequencies and designated carriers for both countries. Concurrently, the need for visas to enter either country was cancelled. Germany – following the new aviation agreement signed between Israel and Germany in January 2009 and following the redistribution of routes between German companies, Lufthansa added a fifth weekly flight on the Tel Aviv-Munich route starting late April 2010 and Air Berlin (which replaced Hapag-Fly) began operating 7 weekly flights to various German destinations (2 from Munich, 3 from Berlin and 2010 from Cologne) starting April 2010 and starting June 2010 added 2 additional 2 flights on the Tel-Aviv-Dusseldorf route. In addition, in late March 2010 German Wings, a Lufthansa subsidiary, began operating flights on the Tel-Aviv-Cologne route.
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Spain - in May 2010 Spanish airlines Spanair and Vueling began operating scheduled flights on the Tel-Aviv-Barcelona route. Note that Vueling discontinued its activity on the route in November 2010.
A number of airlines operating scheduled flights to and from Israel discontinued services over the course of 2010: UK airline BMI on the Tel Aviv-London route (January 2010); Greek airline Olympic Air, which operated flights on the Tel Aviv-Athens route, lost its right to operate flights on the route to Israel to its Greek competitor Aegean Airlines, starting January 2010; and as noted above, Hapag Fly, part of the TUI Corporation, which was replaced by German airlines Air Berlin, German Wings and as noted above, Spanish airline Vueling. Over the past four years new aviation agreements have been signed between Israel and a large number of countries (Spain, Italy, France, the UK, Belgium, Russia, Ukraine, Slovakia, Thailand, South Korea, Germany, Switzerland, Brazil, Turkey, the U.S., Greece, Rumania, Georgia and Jordan). All of these new aviation agreements expressed the liberalization of air transportation, via agreements for multiple Designated Carriers for each side as well as a significant increase in frequency allocations for scheduled flights. These agreements allowed an increase in the number of companies operating scheduled passenger flights and the launching of low cost flights to Israel. Furthermore, cancellation of the section of the 2003 government resolution limiting the appointment of Israeli carriers on routes operated by El Al, allowed the Ministers of Transportation to appoint Israeli airlines as additional designated carriers on a series of international routes. The prominent routes in which the appointment to scheduled flights was exercised by Aria and Israir over the course of the year are the routes to Paris, Barcelona and Munich, operated by Arkia, and routes to Rome, Milan and Berlin operated by Israir. Overall, in 2010 the capacity of other scheduled airlines (including regular Arkia and Israir flights) increased by 10% and passengers increased by 14% compared to 2009. As noted, the first half of 2009 was influence by Operation Cast Lead and by the economic crisis and therefore, note that also compared to 2008, a record year in terms of traffic to and from Israel, the other scheduled airlines significantly increased their capacity and passenger numbers (17% and 16%, respectively). Airlines increasing their frequency and capacity in 2010 to a significant degree were Lufthansa, Alitalia. Austrian, TAROM, LOT, Royal Jordanian, Delta and Air Canada. The increase in capacity allowed these companies operating an international hub at their home airports, to increase the number of passengers flied between Israel and a large number of destinations via indirect flights, taking advantage of their route networks (Sixth
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Freedom traffic) and that of their partners in global aviation alliances and code sharing agreements. The Group increased its seat capacity by 6% (9% over 2008) and listed an 8% increase in passenger numbers compared to 2009 and 2008. A 9% increase was listed in the volume of passenger at BGN in 2010, with a 12% increase occurring in scheduled passenger travel (including the Company) and a slight 1% decrease in charter flights compared to last year, deriving mainly from the continued drop in charter traffic to Turkey. Overall, charter traffic (including Sun D'Or flights) through BGN constituted 15% of all traffic, compared to 17% in 2009 and 22% in 2008. Passenger traffic through BGN in 2010 was divided as follows: the Group: 37.1%; other scheduled airlines – 51.2%; charter airlines (not including Sun D'Or) – 11.8%. In light of the extraction form the economic crisis and recovery in international passenger traffic, both business and tourist, competition is expected to continue growing fiercer in 2011 as well as a result of the entry of additional foreign airlines such as Danish airline Cimber, which operates, starting from November 2010, three direct and scheduled weekly flights from Copenhagen to Tel Aviv, and also announced its intention to increase this to 4 weekly flights starting from April 2011. Furthermore, competition is expected to escalate as a result of increased capacity and/or frequency and destination expansion by existing airlines as well as the operation of scheduled flights to new destinations by other Israeli airlines. Prominent examples are: British low-cost airline Easy Jet, which began operations on the Luton-Tel Aviv route in November 2009, and over the course of 2010 also began to operate 4 weekly flights on the Geneva-Tel Aviv route (starting late August) and 3 weekly flights from Tel Aviv to Basel (starting December 2010), and starting November 2010 added an additional flight on the Luton- Tel Aviv route (its seventh). Lufthansa, which added a fifth flight to Munich in April 2010 and announced its intention to double its seat capacity on this route over the course of the winter 2010/11 season. Iberia added 3 flights on the Tel Aviv-Madrid route starting December 2010 and is expected to add an additional flight starting April 2011. In total, Iberia is expected to operate 18 weekly flights on the Tel Aviv-Madrid route. The added flights on the route to and from Israel constitute part of the new collaboration between Iberia, American Airlines and British Airways, intended to increase Sixth Freedom movement to goals in North America and Latin America. Hungarian airline Malev announced its intention to add a third daily flight on the Budapest-Tel Aviv route in March 2011. Malev recently deepened its collaboration with American Airlines as part of its One World alliance and the increased capacity to Israel was intended, among other things, to increase the number of passengers to the U.S. through Hungary.
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Air France announced that it would be adding a third daily flight on the Tel Aviv-Paris route in July-August 2011. Korean Air announced that it would be operating 4 weekly flights on the Tel Aviv-Seoul route instead of 3 weekly flights for two months in two different periods: April-May and September- October 2011. Polish airline LOT announced that starting April 2011 to September 2011 it would be operating 7 weekly flights on the Tel Aviv-Warsaw route, and subsequently returning to a format of 6 weekly flights. In addition, it intends to integrate a flight on the Tel Aviv-Krakow-Warsaw route. Russian airline Aeroflot, which starting April 2011 intends to operate 7 weekly flights (instead of 5) and Belgian airline Brussels Airlines, which announced that it would be increasing its capacity on the Tel Aviv-Brussels route by changing to a larger aircraft. The Company's estimates regarding increased competition in 2011 and its possible impact on the Company are forward-looking information as defined in the Securities Law based on the influence of the Open Skies policy, including the increase in the number of foreign airlines operating at BGN, and the increase in the capacity of foreign airlines operating today. The actual level of the increase and its impact on the Company are influenced, inter alia, by economic, security and geopolitical factors and by trends in the airline industry. For further details see 7.1.4 above. For regulatory changes that may alter the structure of competition in the field of activity – see Section 9.11.2 below.
The Open Skies Agreement with the European Union In accordance with the aforementioned commission recommendations, talks began in November 2007 between Israel and the European Union, the objective of which are to eliminate the need for separate agreements with each European country, and the execution of one general agreement with the Union's executive, in order to foster aviation liberalization that will increase competition and freedom of movement between the airlines. In February 2008, Israel and the European Union Commission signed a preliminary memorandum of understanding, toward the signing of a uniform global aviation agreement between European countries and Israel. In December 2008, a new aviation agreement (the "Horizontal Agreement") was signed between Israel and the EU. The Horizontal Agreement updates the sections of the bilateral aviation agreements between Israel and the EU members referring to the ownership and control of Designated Carriers (without changing the aviation rights established in the bilateral agreements) and allows airlines controlled and owned in one of the EU members to operate
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scheduled flights from any other country in the EU, subject to the bilateral agreement (for example: Sky Europe Airlines, which is owned by Austrian citizens, may operate scheduled flights between Slovakia and Israel, subject to the aviation agreement between Israel and Slovakia). The Horizontal Agreement does not influence the aviation rights determined as part of the bilateral agreements. These rights include, inter alia, the right to operate scheduled flights on agreed-upon routes, the number of companies on each side entitled to operate flights on these routes (Designated Carriers) and the weekly frequency quota granted Designated Carriers. At the same time, the Horizontal Agreement may in the future allow the realization of aviation rights not realized to date on the lines between Israel and the EU and pave the way for a global aviation agreement with the EU. In addition, the parties agreed to establish the framework and content of the negotiations for the global aviation agreement and negotiations have begun for a global aviation agreement. The first round of talks between Israel and the EU regarding the global agreement ("the "Vertical Agreement"), which is designed to replaces all of Israel's bilateral agreements with EU members and to gradually cancel the limitations on the number of carriers, frequencies, capacity and type of aircraft, were held in December 2008. Additional rounds of meetings between the parties were held over the course of 2009 and 2010 and talks continued regarding a global aviation agreement between Israel and the EU. The latest round of talks with the European Union took place in January 2011 and differences and disagreements still exists between the parties. An additional round of talks is planned for May 2011.
c) Charter Airlines
In 2010, in light of the continued deterioration in Israeli-Turkish relation as a result of the Turkish flotilla events, traffic to Turkey continued to drop, in particular charter flights to Turkish resort destinations (56% compared to 2009 and 75% compared top 2008), which led to a 1% decrease in all charter traffic to and from Israel. The share of charter airlines (Israeli and foreign) of total passenger traffic through BGN amounted to 15% in 2010, versus 17% in 2009 and 22% in previous years, as detailed in the following table:
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Year Share of Charter Airlines from Total Passenger Traffic through BGN
2010 15%
2009 17%
2008 22%
2007 22%
2006 21%
Note that the Turkish flotilla events led to a change in preferred destinations of the Israeli public, who preferred resort destinations in Greece and Bulgaria in 2010. After deducting the traffic to Turkey, charter traffic to other destinations through BGN increased 24% compared to 2009 and 4% compared to 2008.
d) Low Cost Airlines
Airlines referred to as low cost airlines have become active in recent years. These airlines maintain low costs and generally offer very competitive prices, while providing a low level of service and using alternate, less desirable airports. These airlines have succeeded in growing enormously in the United States, in Canada and in Europe. Stirrings in this field have also been felt recently in Asia. The entry of the low cost airlines into certain markets forces the airlines competing in these markets, which do not have a low cost structure like the low cost airlines, to become more efficient in order to reduce their costs. Until now, the low cost airlines have operated on short flights, and have not operated on flights to and from Israel. Starting 2006, several subsidiaries of the German aviation and tourism giant TUI began operating as Designated Carriers on routes from various European countries to Israel. In May 2009 the airline Thomsen Fly, a member of the TUI Corporation, discontinued its activity on the Luton- Tel Aviv and Manchester-Tel Aviv routes. Thomson Fly was replaced by British low cost airlines such as Jet2.com which began operating scheduled flights on the Manchester-Tel Aviv route and EasyJet, which began operating scheduled flights on the Luton-Tel Aviv route and which began operating scheduled flights on the Geneva-Tel Aviv and on the Basel-Tel Aviv route in 2010.
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Over the course of 2010, following the redistribution of routes to Israel between German companies, Hapag Fly, also a member of the TUI Corporation discontinued its activity on routes
to Israel as well. German airlines Air Berlin and German Wings began operating flights from a number of German destinations using a low cost format. In addition, over the course of 2010 two Spanish airlines (Spanair, Vueling) began operating low cost flights on the Barcelona-Tel Aviv route. In addition to the above, Israeli airline Arkia began operating starting November 2010 low cost flights on the Tel Aviv-Paris and Amsterdam-Tel Aviv routes and added 3 new low cost destinations: Moscow, Kiev and Rome. The low cost flights to Kiev and Moscow began in March 2011 and to Rome shall begin in May 2011. The entry of these and other airlines into the Israeli market could have a negative effect on the Company's business results, due to the increased capacity offered by these airlines at reduced prices. The Company's estimates regarding the entrance of these companies may be different or incorrect an in such a case the scopes of activity of these companies may differ from the Company's estimates. The Company's estimates regarding the scopes of activity of the low cost companies and the future development of this activity in Israel constitutes forward-looking information as defined in the Securities Law. This estimate is based on the fact that this activity involves operating difficulties that might arise such as a shortage in a critical amount of passengers, which this activity requires, difficulty in quick flight turnaround (ground time of no more than an hour) and more.
e) Domestic Flights
The Company approached the Civil Aviation Administration with a request to be appointed Designated Carrier on the domestic route to Eilat. In August 2009, the Minister of Transportation approved, in principle, the CAA recommendation to allow the Company to operate scheduled flights between BGN and Eilat, alongside Arkia and Israir. The Minister of Transportation noted that the starting date for the flights, their frequencies and load factors the Group will be able to operate will be determined following thorough staff work carried out by
the Civil Aviation Authority. In September 2009 Israir and Arkia petitioned to the High Court of Justice against the Minister of Transportation, the CAA, the Restriction of Trade Commissioner and the Company, for an injunction against the Minister of Transportation's decision allowing the Company to operate scheduled flights from BGN to Eilat.
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In October 2009 the CAA recommended to the Minister of Transportation that he approve up to 2 daily frequencies on the BGN-Eilat route, this contrary to the Company's request to approve more extensive activity on this route. In January 2010 the High Court of Justice rejected the petitions of Arkia and Israir, on the grounds that the petition had been filed too early. At the same time, the Court permitted the two companies to file a repeat petition after the terms of the route's operation (frequencies and capacity) are determined and within 30 days from the publication of the final decision of the Minister of Transportation and Road Safety and prior to the Company's initiation of activity on the route. On February 4 2010 the Minister of Transportation accepted the recommendations of the CAA and decided the following: " 2. To allow El Al Airlines to operate the scheduled Ben Gurion Airport-Eilat-Ben Gurion airport route in the following manner: 2.1 El Al shall be required to operate at least one flight per day each direction, on five out of seven days a week. El Al shall offer at least 100 seats in each direction on each of the frequencies noted in this section. 2.2 El Al shall not be entitled to operate more than three frequencies a day in each direction. In addition, El Al may not offer more than 430 seats a day in each direction. So as to remove all doubt – this restriction applies to seats and not to actual passengers. 3. The frequent flyer programs operated by the Company separate international and domestic services as follows: 3.1 In sales of tickets for the BGN-Eilat-BGN route, El Al shall not be permitted to accept as payment Frequent Flyer points accumulated by its passengers as a result of purchasing flight tickets on international routes operated by the Company. In addition, El Al shall not be entitled to grant frequent flyer points for the purchase of tickets for the BGN-Eilat-BGN route usable on international routes operated by the Company. 3.2 El Al may grant frequent flyer points for the purchase of tickets for the BGN-Eilat-BGN route for use on the BGN-Eilat-BGN route only. From the sale of tickets for the BGN-Eilat-BGN route, El Al may only accept as payments frequent flyer points accumulated by its customers as a result of purchasing tickets for the BGN-Eilat-BGN route only. 4. To carry out the process required by law for the purpose of establishing a uniform maximum price for all airlines operating on the BGN-Eilat-BGN route and the Sdeh Dov-Eilat-Sdeh Dov route, equaling the following sums: ………………………………………. These maximum prices are for one direction only. Maximum prices for the Haifa-Eilat-Haifa route shall remain unchanged. 5. To free Israir from its obligations towards the flight schedule and seat offerings to which it committed itself in the 1995 Ministry of Transportation tender, and allow it to establish its schedules for the Sdeh-Dov-Eilat-Sdeh –Dov and BGN-Eilat-BGN routes as it sees fit. 6. The conditions denoted in this resolution shall remain in effect for a period of six months from the beginning of flights by El Al. At the conclusion of the six month period, the impact of El Al's entry into the BGN-Eilat-BGN route shall by studied based on the characteristics of the route at the time, and the alteration or even cancellation of the above conditions shall be considered. This condition shall be noted explicitly in the terms of the license. 7. This resolution shall not be applied prior to 30 days from today."
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On March 10 the Company filed a petition to the High Court of Justice against the decision by the Minister of Transportation on the matter of the license granted the Company to operate the Eilat route (the "Decision"), pursuant to which a temporary order was requested instructing the Minister of Transportation and the Head of the Civil Aviation Authority to explain why the Court should not rule that the restrictions placed on the Company in the Decision as detailed above be cancelled, as well as why the court should not instruct them to clarify why the Company's license needs to be reexamined after a period of six months. Note that on March 8 2010 Arkia filed a petition before the High Court of Justice against the Minister of Transportation and Road Safety, the Civil Aviation Authority and the Company (hereinafter: "the "Respondents") and on March 9 2010 Israir filed a similar petition before the court. In these petitions the court was asked to issue a temporary order instructing the Respondents to explain why exactly the Minister of Transportation's authorization from February 4 2010 to allow the Company to operate direct flights between Ben Gurion Airport and Eilat should not be revoked. In addition, the court was asked to issue an interim order (or alternately an injunction until a hearing is held on the petition) instructing the Respondents to avoid realizing the decision until the petition is resolved. The Supreme Court did not issue am interim order in the petitions filed by Arkia and Israir and the court consolidated the petitions. On June 27 2010 the High Court of Justice ruled to reject the petitions filed by Arkia and Israir against the ruling, and ruled to reject the petition filed by the Company on the matter of the terms set in the decision, and charged the petitioners for court expenses. In August 2010 the Company began operating 3 daily flights on the BGN-Eilat route, in accordance with the terms set in the decision made by the Minister of Transportation and Road Safety. In August-December 2010, the Company flew 96,000 passenger legs and its share of domestic traffic to Eilat in this period was 16%.
7.2 Services in the Area of Activity
a. General The main services provided by the Company in this field of operations are air transport of passengers and cargo to various destinations by using passenger aircraft. As of immediately prior to the approval of the report, the Group operates flights in passenger aircraft to 36 destinations in 26 countries in Europe, North America, East and Central Asia and other destinations. Additionally, the Group operates flights from a number of locations in Europe to Eilat and as noted above, has begun operating domestic flights on the BGN-Eilat route. In 2010, the Company operated an average of 231 weekly flights on in each direction. In addition to the flights it
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operates, the Company markets flights in the framework of interline agreements with other airlines, which make it possible for passengers on scheduled flights, subject to certain restrictions, to use airline tickets issued by another airline, for flights of the other airlines. The company whose flights are used by the passenger submits the bill for payment to the company that issued the flight ticket. The accounting between the airlines is done on a monthly basis, generally through IATA's clearinghouse. The scheduled airlines also operate flights in the context of “code sharing”. The use of the code sharing permits the air carrier to market flights operated by another air carrier as if they were its own flights, so that the passenger orders the flight through one carrier, despite the fact that, in practice, his flight is with another carrier. The code sharing provides the participating carriers with the possibility of increasing the frequency of the flights offered to its customers, accessibility to additional destinations and also marketing advantages, including amplifying the attractiveness of joining the Group’s frequent flyer club. The Company has also operated in this area in recent years. For information regarding legislative changes in the antitrust field and details of the Company's code sharing agreements, see 7.4 and 9.11.2(i) below. In its scheduled flights, the Group operates four service sections that are distinct one from the other in the type of seat, the space between the seats, the food and beverage menu, the manner of serving, the assortment of convenience and leisure products and the number of flight attendants in relation to the number of passengers. The sections are first class, improved business class - platinum, business class and economy class. The charter flights operate a service profile suitable for charter operations. Not all classes operate in all flights. All scheduled flights contain a system of programs of audio, films, screened magazine and printed magazine and services are provided for the sale of duty free products. In March 2008, the Company entered into a collaboration agreement with Keshet Broadcasting Company Ltd. and Channel 2 News Company to show Keshet entertainment programming and its daily news edition on flights. In addition to scheduled flights, the Company is engaged through Sun D’Or, in carrying out charter flights by leasing capacity in aircraft to organizers of charter flights at prices agreed upon in advance, and the sale of blocks of seats to agents. The Group’s flights are supported by a system of ground services that administers the processes of boarding passengers and their baggage, their alighting at their destinations and unloading their baggage, and cargo handling. The ground services are provided at BGN and at each of the destinations at which the Group’s aircraft land. At the same time, the Company, as directed by government security authorities, operates a ground security array in each of the overseas airports
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at which Israeli airlines land and a system of air security, which operates on flights of passengers of Israeli airlines (the ground security system at BGN is operated by the IAA).
b. Data Regarding the Destination Groups of the Group The following is data regarding the Group's market share in groups of key destinations, relative to all passenger traffic to or from BGN, broken down into these destination groups: To/From BGN Total Passenger Traffic Through BGN By Company estimates of Destination According to Direct Flights20 market Company share
(In Thousands of Passenger Legs) (in %)19
Change in % 2010 2009 2008 2010 2009 2008 In 2010 North America 10.8 1,690 1,525 1,568 38.0 40.0 42.0
Europe 12.3 7,730 6,886 7,078 40.0 41.0 40.3
East and Central Asia21 11.2 437 393 368 60.0 59.0 60.2
Others22 (3.8) 1,593 1,656 2,012 16.0 15.2 9.8
Total 9.5 11,450 10,460 11,026 37.1 37.5 35.7
c. Routes to North America (to the United States and Canada)
19 This data has been broken down by the passenger’s final flight destination (including the final destination in Sixth Freedom flights). The Company’s estimate concerning the passenger’s final destination is based upon data from global distribution systems. The Company cannot estimate the precision of the data received from the distribution systems, which include paying passengers only. Note that the Civil Aviation Authority publishes data that includes non-paying passengers and which is broken down by the airlines carrying out the flights. Thus, in cases of Sixth Freedom flights of European airlines between Israel and the U.S. through European airlines – the flight shall be attributed to the parent company of the European airline. According to the Company's processing of the Civil Aviation Authority data and cross-sectioning of flights to the airlines’ parent companies, while ignoring Sixth Freedom flights), the Company’s market shares were: on the North America route: 44.5% in 2010 vs. 48.5% in 2009; European routes: 36.7% in 2010 compared to 37.6% in 2009; in East and Central Asian routes: 85.9% in 2010 compared to 88.7% in 2009; in other destinations: 16.8% in 2010 compared to 14.2% in 2009. 20 Civil Aviation Authority data refers to the airlines making the flights and not the flights’ destinations. Therefore, this data constitutes the group's estimates based on an analysis of Civil Aviation Authority data. This data has been broken down by the direct flight destination and do not take into account passengers’ real destination in the case of foreign airline Sixth Freedom flights. 21 The Group is unable to assess the level of precision of its market share estimate which includes Sixth Freedom flights in the East and Central Asia market, Africa and regional destinations (such as Turkey, Greece and Cyprus), this in view of the lack of precision of the information in the Company’s possession regarding the number of passengers of other airlines in these markets. 22 Others: passengers to regional destinations (Cyprus, Egypt, Greece, Jordan, Malta and Turkey) and Africa. Starting May 2009 the Company has operated direct flights to Brazil. Therefore, in 2010, passengers on these flights have been included under “Others" (regional destinations, Africa and Brazil).
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During the height of the 2010 summer season, the Company operated 33 weekly flights to North America and during the winter season, it operated some 22 weekly flights (mostly to New York).
Competition exists between Continental, Delta, Air Canada and U.S. Airways on the routes to North America. In addition, intensive activity by European airlines taking traffic to the United States and Canada via their home airport (Sixth Freedom) continues. Overall, 2009 saw an 11% increase in transatlantic passenger traffic over 2009. The scheduled foreign airlines operating on transatlantic routes increased their seat capacity by 18% in 2010 compared to 23009 and also listed a 19% increase in their traffic. Most of the increase in the capacity of foreign airlines derives from the increased capacity offered by Delta Airlines on the New York route, which saw an 47% increase in Delta’s seat capacity, which in total listed an 15% increase in seat capacity on routes to the U.S. (New York and Atlanta), along with a similar increase (16%) in passenger traffic. Air Canada also significantly increased its seat capacity and passenger traffic (by 27% and 24%, respectively), by adding frequencies. The Company increased its capacity on these routes by 2%, and the Company's passenger traffic increased at a similar rate. On the route in question all of the airlines (Israeli and American) had full freedom of action in the matter of rates, frequencies, types of aircraft, aircraft configuration and so on. The Company, as Designated Carrier to the U.S., has the right to carry passengers, cargo and mail to/from New York and other points in the U.S., some as part of a code sharing agreement with American Airlines. This agreement allows the Company to offer its passengers dozens of central destinations in North America, relying on the Company's network of direct routes. However, at the moment, and in light of the lowering of Israel's flight safety rating to Category 2 by the FAA in December 2008, American Airlines has dropped its code from Company flights and at this stage the agreement is implemented unilaterally, with the Company permitted to sell tickets with the Company's code for American Airlines flights, but American Airlines not selling tickets with the American Airlines code on Company flights. For details regarding the aviation agreement between Israel and the U.S. see 7.1.10.b above. Note that United Airlines and Continental Airlines have merged into the world's largest airline. As part of the merger, the name of the joint airline was changed to United, while the continental logo was kept on the aircrafts’ tails. These developments may have an impact on the intensifying competition on the transatlantic routes. The Company's estimates regarding the changes in capacity and frequency of other airlines and the intensifying of competition constitutes forward-looking information as defined in the
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Securities Law. This information is based, inter alia, on the Company's estimates in light of the Group's current scopes of activity and the level of market competition that may not be realized in whole or in part, or which may be realized in a significantly different manner. The actual situation may differ from projections among other reasons due to the opening of the market to additional competition, regulatory changes, the manner in which the Company deals with competition and the risk factors listed in Section 9.18 below as well as economic, security and geopolitical changes. d. Routes to Europe The Company has scheduled flights to 25 destinations in Europe, with the key destinations being London, Paris, Frankfurt, Rome, Milan, Madrid and Zurich. The Company competes on the routes between Israel and Europe with the national Designated Carriers of the destination country, as well as with other scheduled airlines that take Sixth Freedom traffic to other countries via their home airport, and with foreign and Israeli charter airlines that operate charter flights to various destinations in Europe. In this regard, it should be noted that European scheduled airlines flying to Israel have an advantage over the Company, since they have the ability to offer continuing flights to destinations to which the Company does not fly. The Group, as a designated carrier, has the right to transport passengers, cargo and mail to and from various European destinations, some applied in effect pursuant to code sharing agreements only. In 2010, the liberalization of the Israeli aviation industry continued, with the signing of new aviation agreements with several European countries, the appointment of additional Designated Carriers on these routes and approvals granted by Israeli authorities to increase capacity for foreign airlines. On European routes, competition intensified with the entry of additional designated carriers for routes to Germany, Spain, Switzerland, Denmark, Russia, Ukraine and Armenia (see Sections 7.1.1, 7.1.4, 7.1.8 and 7.1.10 for details), and increased capacity and/or frequencies on behalf of existing airlines. In addition as detailed above, over the course of 2010 Israir, Arkia and Sun D'Or were appointed Designated Carriers to additional destinations. For details regarding the appointments as Designated Carriers for other airlines see 7.1.2.(d) above and 9.11.7.2 below. Note that in spite of the above, Arkia, Israir and Sun D'Or still operate charter flights on some of the aforementioned routes. Western European routes saw a 10% increase in total passenger traffic (+8% compared to 2008) with the other scheduled airlines (including scheduled flights from Arkia and Israir) increasing their seat capacity by 6% and listing a 10% increase in passenger traffic (a 19% increase in
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capacity and 18% increase in passengers compared to 2008). Foreign charter airlines increased their seat capacity by 37% and their passenger traffic increased by 39%. The Group increased its seat capacity on these routes by 7% and listed a 10% increase in passenger traffic. Note also that Sun D’Or listed a significant increase in Western European route activity and in particular on routes to Italy (48%), Spain (49%), France (15%) and the Netherlands (72%). Regarding routes to Central and Eastern Europe, no material changes occurred to the Group’s seat capacity (2%+) and in total the Group increase the number of its passengers by 3%. The other scheduled airlines operating on these routes increased their seat capacity by 6% and their passenger traffic increased by 10%. A significant increase (27%) was noted in foreign charter activity. In total, passenger traffic on these routes increased by 12% over 2009 (a 7% increase over 2008). Routes to Russia and CIS states listed a significant increase in total passenger traffic (+23%) and in seat capacity (21%). The scheduled airlines operating on these routes (including Israir and Arkia) increased their seat capacity by 28% and their passenger traffic increased by 33%. Competition on these routes intensified significantly in 2010 with the entry of a number of new airlines – Aeroflot on the Moscow-Tel Aviv route, Ukraine Air International on the Kiev-Tel Aviv route and DonbassAero, which operated alongside Aerosvit, on routes between Ukraine and Israel up to July 2010 and also operated special flights in September 2010 (due to Hassidic flights to Uman in that month). For further details see 10.1.7.b below. In addition to the above, the other scheduled airlines operating on these routes also increased their seat capacities both by adding frequencies and by moving to larger aircraft. The most prominent airlines to increase their seat capacity and passenger traffic were: TransAero, which increased its capacity by 7% and listed a 7% increase in passenger traffic; Air Baltic, which increased its seat capacity by 31% and listed a 35% increase in passenger traffic; Rossiya Airlines, which listed a 16% increase in its seat capacity and listed a 18% increase in passenger traffic. The Group increased its seat capacity on these routes by 17% and listed a 14% increase in passenger traffic. In total, passenger traffic to Europe (East, Central, CIS and West) increased by 12%, with other scheduled airlines increasing their passenger traffic by 14%. The Group’s passenger traffic to these destinations increased by 10%. Aviation agreements signed over the past four years as well as other agreements including the global agreement between Israel and the EU members those expected to be signed in the future and the Government resolution regarding a change in the Open Skies policy are expected to lead
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to the operation of scheduled flights to and from Israel by other airlines, and to an increase in the capacity and frequency and/or an expansion in destinations among the existing airlines. Therefore, in 2011, a further increase is expected in the competition for traffic on these routes. The Company's estimation regarding the increased capacity and frequency among the other airlines and the intensifying competition are forward-looking information as defined in the Securities Law. This information is based, inter alia, on the Company's estimates in light of the Group's current scopes of activity and the level of market competition that may not be realized in whole or in part, or which may be realized in a significantly different manner. The actual situation may differ from projections among other reasons due to the opening of the market to additional competition, regulatory changes, the manner in which the Company deals with competition and the risk factors listed in Section 9.18 below as well as economic, security and geopolitical changes.
e. Routes to East and Central Asia In September 2008 Korean Air began operating three regular passenger flights per week on the Tel Aviv-Seoul route. Other than the Company, which operates on routes to India (Mumbai), Thailand (*Bangkok), China (Beijing) and Hong Kong, scheduled airlines that operate in Israel operate flights to these destinations in the context of Sixth Freedom traffic. In total, the supply of seats in these routes increased by 4% in 2010 compared to 2009 and the number of passengers on these routes increased by 11% (a 19% increase over 2008).
f. Other routes The other routes that the Company operated during 2010 were Greece, South Africa, Egypt and Brazil. As mentioned, due to a lack of economic feasibility Israeli airlines, including the Group, discontinued their flights to Turkey starting March 2007. The Group renewed its activity on the Turkish routes in July 2008 via Sun D'Or flights, currently operating as charter flights. Arkia and Israir as well have begun operating flights to Turkey, albeit at insignificant levels. However, since due to the continuing tension between Israel and Turkey following Operation Cast Lead and following further deterioration of relations between the countries after the Turkish flotilla events in May 2010 and the sharp drop in passenger traffic to Turkish resort destinations (-59% compare to 2009 and -74% compared to 2008), Israeli airlines avoided operating flights on routes to Turkey. Foreign charter flights decreased their seat capacity by 55% and listed a similar drop in passenger traffic on Turkish routes. Most of the passengers on charter flights operated by
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Turkish airlines are day visitors; these are mainly tourists from the CIS arriving to vacation at
Antalya, and flying in for a day in Israel as part of their package. In all, passenger traffic on regional routes and on African routes decreased by some 5% (24% compared to 2008) and the number of Group passengers on these routes increased by 6% compared to 2009 (a 4% decrease compared to 2008). As stated above, the Company began operating regular direct flights between Tel Aviv and Sao Paolo, Brazil starting May 2009. The Group's market share of these destinations was 16% in 2010. In addition, from time to time the Group operates unique charter flights or short series of charter flights to various destinations.
7.3 Analysis of Revenues and Profitability from Services In 2010 the Group's revenues from this area of activity increased by 18.5% compared to revenues in 2009, with the rate of increase in passenger traffic through BGN in 2010 being 9.5% versus
2009.
For details regarding the breakdown of the Company’s revenues and profitability (consolidated) by reported operating segments in the area of passenger aircraft see Section a.5 of the Board of Directors Report.
7.4 New Services The Company began operating its domestic flights on the Eilat route in August 2010 (for
additional details see 7.1.10 above). Starting December 2010 Company passengers, in all classes, have been served breakfasts from the kitchen of Chef Segev Moshe, recently appointed the Company's chief chef. The new meals were launched following a process lasting several months in which Chef Segev studied the aviation world and the Company’s characteristics and in which new menus were also prepared with special emphasis placed on health and freshness components and in which serving utensils were also replaced. The Company selected a presenter from the world of styling in order to renew the duty free items sold on Company flights, changing them from a catalog of products to a lifestyle-type booklet, with fashion productions integrating the Company’s duty free items and so on. To date, two booklets with the unique new format have been marketed, which are expected to improve the shopping experience.
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The Company, in conjunction with VIP Lounges from the Dan Hotels and QIS Limited Partnership and Home Check-In is launching a private terminal service, while will provide rapid and accessible access for Company luxury passengers which includes a check-in process at the passengers’ home, transportation to the airport, border inspection processes at the Masada
Lounge and transportation to the aircraft doors. Starting from January 2011, the Company established a cigar room in the Company lounge. This service is provided to the Company’s luxury passengers and allows lounge guests to smoke cigars in a designated area while at the same time exposing them to the variety of cigars sold on
airplane duty free shopping and allowing them to purchase these products on their flights. In order to improve the in-flight entertainment experience, the Aviad Kissos and Tal Berman morning show will be broadcast on Company flights. In March 2011 a joint venture was launched between the Company and Stimatzky’s Books – “Our Story”, in which Company customers are invited, during their flights, to take part in an award- bearing short story competition on the subject of “home”. All revenues pursuant to this collaboration constitute charitable donations. The Company has launched a new service, in collaboration with Harel Insurance, in which Company customers purchasing flight tickets on the Company's website can also purchase overseas flight insurance. The insurance can be personalized based on the destination and the
nature of the trip. From time to time, the Group assesses the possibility of increasing the frequency to existing destinations and the possibility of operating flights to new destinations, meeting market demand, inter alia, through other code sharing agreements with other airlines. For details regarding
regulatory approvals necessary for such agreements see 9.11.2.i below.
In 2010 the Company entered into the following code sharing agreements: In March 2010 a code sharing agreement signed with Air China in June 2009 came into effect. In a later stage the Company intends to add its code to internal Air China flights from Beijing to other Chinese destinations, both ways, and possibly on international Air China flights (subject
to regulatory approval from third nations). Regarding the Company’s reports regarding the code sharing agreement signed December 2009 with Turkish airline Atlas Jet, which was expected to come into effect in June 2010, the Company and Atlas Jet decided via mutual consent and in light of the situation following the
flotilla events to freeze activity on the route to Istanbul until further notice.
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In November 2010 the Company signed a code sharing agreement with Russian airline Siberia Airlines (hereinafter: “S7”) on the Tel Aviv-Novosibirsk route. The purpose of the agreement is to expand the Company’s Russian destinations and open the door to expanding cooperation to additional Russian destinations. The agreement is based on a two-way free sale format and shall apply to the Company’s flights to Moscow and to S7 flights to Novosibirsk connecting to these flights, for both ways. Sales shall be made directly from the seat inventory of each of the airlines, while defining the appropriate listing classes and price levels for each class and each flight segment. The agreement was approved by the Minister of Transportation and Road Safety and the Restraint of Business Supervisor, as required, and came into effect and has been applied
starting late December 2010. In November 2010 the Company signed a code sharing agreement with Bulgaria Air for the Tel Aviv-Sofia route. The chief purpose of the agreement is to provide the Company's customers with an improved product, and the agreement shall apply to all the flights each party operates on the route, in a block space seat swapping format, and accordingly, each party shall offer the other part of the aircraft’s load for sale in flights operated by them. Note that a code sharing agreement between the parties had been in effect for the route up to 2009, before it was cancelled in light of the absence of approval from the Restraint of Business Supervisor. The current agreement requires the approval of the Restraint of Trade Supervisor and the Minister of Transportation and Road Safety as well as approvals by relevant Bulgarian authorities, as a
precondition for its activation. In December 2010 a code sharing agreement was signed with Armenian airline Armavia Air (hereinafter “Armavia”) for the Tel Aviv-Yerevan route. The agreement is based on a soft block format, and according to it Armavia shall provide the Company with seats for sale on both of Armavia’s weekly flights on the route. The agreement was approved by the Armenian aviation authorities and by the Israeli Minister of Transportation and Road Safety and the
Restraint of Trade Commissioner and is expected to come into effect starting late March 2011. In December 2010 the Company signed a code sharing agreement with Ukrainian airline Aerosvit, for the Tel Aviv-Kiev route. The agreement is based on a two-way free sales format and shall apply to each party’s flights in accordance with the terms agreed upon. Sale shall be made directly from the seat inventory of each of the companies, while defining the appropriate listing classes and price levels for each class and each flight segment. Note that a code sharing agreement between the parties had been in effect in the past, using a block space format. This agreement was cancelled in 2009 due to the lack of an approval from the Restraint of Trade Supervisor. The current agreement requires the approval of the Restraint of Trade Supervisor
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and the Minister of Transportation and Road Safety as well as approvals by relevant Ukrainian
authorities, as a precondition for its activation. The Company signed a cooperation agreement (on an interline basis) with Jet Blue Airlines, which operates a large volume of domestic U.S. flights departing from JFK Airport in New York. The agreement came into effect in November 2010, allowing the Company to offer a
variety of new connecting destinations throughout the U.S, Latin America and the Caribbean.
7.5 Customers The Group renders its services to passengers who are both members of households and of the business sector. The majority of the airline tickets of the Group are sold by means of travel agents and marketers of tourism packages, and directly by the Company to institutions and individuals. See Section 7.6 for additional details. For information on the frequent flyer program see Section 7.6.4 below.
The Group does not have a customer in the passenger aircraft field whose revenues account for 10% or more of total Group revenues. The Group estimates that it is not dependent on any single agent in the area of cargo shipping in passenger aircraft. See Section 8.5 below for details regarding customers of cargo transport services.
7.6 Marketing and Distribution 7.6.1 Travel Agents and Marketers of Tourist Packages Most travel agents are IATA members and sell flight tickets for a number of airlines. Upon making their sale, the agents are entitled to commissions from the airlines at rates determined by them an in accordance with IATA directives23. Agents may occasionally be entitled to additional commissions, including sales incentives, as decided by the airlines.
The vast majority of the marketing of airline tickets to passengers is carried out by means of travel agents and marketers of tourism packages. In addition, airline tickets are sold by the sales offices of the Group and by direct sale over the telephone and the Internet. The Group has 5 sales offices in Israel and 32 sales offices in 22 branches outside the country. In addition, the Group sells airline tickets through 33 overseas general sales agents (GSAs). Air Tour Israel Ltd. (hereinafter- “Air Tour”), which is a company jointly-owned by the Group and by travel agents,
23 For details regarding IATA directives see www.iata.org.
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is an important marketing channel for the Group in the Israeli market, as a distribution arm to all agents in Israel with respect to sales campaigns and packages to all agents in Israel.
In the passenger aircraft transport field, the Group does not have an agent through which sales volume amounts to 10% or more of total Group revenues. The Group estimates that it is not dependent on any single agent in the area of cargo shipping in passenger aircraft. The Group provides support to travel agents and package marketers, inter alia, through the Group’s sales offices. The Company grants commissions and special incentives to travel agents, primarily based on the sales volume of airline tickets. In principle, the consideration to Israeli agents is divided in two: a fixed component (a basic 7% IATA commission) and a variable commission component, as an incentive. There are various methods in use globally regarding this matter, conforming to market needs. In recent years, a trend has developed in the aviation world of transition to a reduced commission system, reaching a “net fare” system (fares without commissions) in such a manner that the agents' base commissions are cancelled and service fees collected by the agents are added. The foreign scheduled airlines operating in Israel have instituted a similar policy to that of the Company, although starting January 2009 the following airlines cancelled the base commission in Israel according to accepted practice in other markets around the world: Lufthansa, Swissair, British Airways, Air France, KLM and Alitalia. In March 2010 Air Canada reduced the base commission paid agents from 7% to 1%, and Austrian Airlines announced that it would be cancelling its base commission for agents in Israel starting October 1 2010 and
members CSA of the Czech Republic and BMI of the UK. Commissions to agents abroad vary from country to country, according to market conditions. See Section 7.1.5 regarding the transition to the BSP clearing system. See Section 8.5 below for details with respect to commissions in the area of cargo transport.
7.6.2 Computerized Reservations System Until 2008, reservations for flights were made by means of the Carmel computerized booking system that also served both as a pricing and as a ticketing system, to which all of the Company's sales offices in Israel and abroad, most travel agents in Israel, general agents of the
Company and a number of large agents abroad were linked. A computerized reservation system displays the up-to-date flight schedule of the Company and of foreign airlines, and enables the users to book reservations and ticket on those companies’ flights. The Group also has agreements with certain international distribution systems that allow
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sale and direct access to the Carmel system by the users of such systems in order to book reservations for Company flights. Subsequently, following the transition to the new Amadeus system, in 2010 the Company completed the transition of its check-in system (DCS activity – Departure Control System) to the Amadeus system. The check-in system is the third module in a system containing and constituting an integral part of the inventory management and reservation module. The application was installed in a gradual fashion at El Al stations in Israel and abroad. These technological changes included, among other things, adjustments and development of applications and interfaces for Company systems, creation of communication for active airports in which the Company operates "online", installation of applications at all stations, including the ACM (Amadeus Customer Management) system and the AFM (Amadeus Flight Management) system, establishing procedures and entering rules into the system, testing applications and preparing instruction systems. In addition, as part of the adapting activity to the new system, more efficient use was made of loading capabilities by calculating weight and balance using concentrated calculated data as well as more efficient supervision of customer treatment procedure. Upon the completion of the transition to the Amadeus system, activity with the Carmel system was discontinued. Furthermore, in order to expand to the Company’s distribution network in offline destinations, an agreement was signed in February 2011 with German company Aviareps regarding the Company’s connection to a IBCS (small BSP) system in five eastern destinations: New Zealand, Singapore, Japan, South Korea and Taiwan, with the goal of penetrating these markets through the distribution systems, with clearance carried out by the IATA IBCS according to the BSP model.
7.6.3 Marketing and Sales to Passengers The Group takes action in order to advertise its services to passengers in the Israeli market and in other large markets. The Group also initiates marketing events, sponsorships and joint efforts. In 2010 the trend of global growth in e-ticketing continued, meaning the direct marketing of flight tickets over the Internet. These trends are intended to reduce airlines' marketing and distribution costs. The Company continues to conform its operations to these trends, by developing means that enable self-service for customers, such as online ticket purchasing, check-in and seat selection, check-in and seat selection at counters in the terminal, etc. The Group sells directly to passengers through the Group's reservations department and website. The Group also operates a business desk to promote sales to business entities, mainly in Israel.
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In order to increase the attractiveness of the Group's flights for passengers interested not only in transporta6tion services to and from Israel, but also in tourism services, the Group markets a variety of ground services for tourists (hotels, tours, car rental) to individual passengers, directly and through agents. For this purpose, the Group markets packages through Air Tour. See Section 9.7.2 (g) below for details. This activity is marketed abroad through Superstar Holdings (England) at the Company’s branches abroad by independent direct marketing or through travel agents. See Section 9.7.1(d) for details. The Group also holds shares in the marketers of packages operating in Israel, Kavei Chufsha Ltd. In February 2011 the Company launched a website offering the Israeli public tourist packages consisting of flights, hotels and vehicles around the world. This site joins a number of sites already in place around the world, in which the Company offers incoming tourist packages (the U.S., Canada, France, and Italy). See Section 8.5 below for details on marketing and distribution of freight transport in the bellies of passenger aircraft.
7.6.4 Frequent Flyer Program As part of its marketing efforts, and in order to reinforce the loyalty of Group passengers, the Group offers special benefits to passengers belonging to its “frequent flyer” club, which is based on a recorded database. The passengers receive points for their flights on all of the international routes carried out by the Group. These points award passengers with various benefits, including airline tickets at a discount or for free (with the exception of a cash surcharge for port taxes and various extra charges, including a fuel surcharge), upgrades to better classes and access to the Company’s lounges throughout the world. Staring January 1 2009 the Company issues reports regarding program liabilities in its Financial Statements according to the IFRIC-13 international accounting regulations. This clarification states that flight ticket sale agreements in which the Company grants its customers frequent flyer points exercisable in the future as flight tickets shall be treated as multi-component transactions, and the payment received from the customers will be allocated between its various components based on the fair value of the bonus credits. The proceeds attributed to the bonus will be recognized as income when the bonus credits are repaid and the Company's obligation to provide
the bonuses is upheld (see Note 2.q.(1) to the Financial Statements) In recent years, the Group has entered into agreements that allow the accrual and redemption of points in other airlines and/or conversion of points/stars from credit cards and other businesses to the frequent flyers club as well as collaborative agreements allowing the accrual of points
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and/or the receipt of other benefits as a result of purchases made from various businesses (compensation is generally paid the Company by the business) and agreements for the use of points at various businesses. In addition, agreements have been made with various non-profit organizations working for social, ethical and humanitarian causes, for the contribution of points to said organizations by club members. The frequent flyers club has hundreds of thousands of members and is composed of a number of ranks according to the activity level of their members: “Regular Frequent Flyer", “Silver”, “Gold”, “Platinum” and "Top-Platinum". Concurrent with commercial changes made in recent years in the club's terms, various technological improvements have also been applied, including upgrading the information system by allowing club members to execute transactions in their accounts through the website, improving the system for routing calls at the service center, improving the format of the customer account statement, and more. Frequent flyer club member traffic during 2010 accounted for 29.7% of the Company's total passenger traffic compared to 31.8% in 2009. The Company's program for cultivating and retaining prestigious customers continued in 2010.
7.7 Reservation Backlog The Company has no financial data regarding the volume of projected revenues from non- cancelable tickets. Furthermore, a portion of these tickets may also be redeemed by the customer over an extended period that does not exceed two years (“open ticket”). The Company has “unearned revenues” deriving from the receipt of advance payments for flights yet to take place as well as from points accumulated by frequent flyer club members as noted above.
7.8 Competition 7.8.1 Overview a. The cargo aircraft transport field is characterized by fierce competition between the airlines
that supply transport services between the same destinations or alternative destinations.
b. The Company serves as the Designated Carrier of the State of Israel to most of the destinations from which it operates scheduled flights to and from Ben Gurion Airport.
c. The Group estimates that, over the course of 2010, competition on flights to and from Israel was with approximately 120 airlines, including Israeli airlines Arkia and Israir (operating both charter flights and scheduled flights to certain destinations), 59 foreign airlines
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operating scheduled flights to 72 destinations in 36 countries and 60 airlines operating charter flights (of which 32 operated throughout the year and the balance operated individual flights). Competition for cargo transport in the holds of passenger aircraft, which is included in this field, is against airlines that transport cargo in cargo aircraft and in the
holds of passenger aircraft. See Section 8.7.1 for additional details.
See Section 7.1.10 above for details on the competitive structure of this field of operations.
7.8.2 The Group’s Market Share in the Service Categories According to the Company's estimates, in 2010 the Group's portion of all traffic to and from BGN amounted to 37.1%, compared to 37.5% in 2009. For the Company's market share of service groups see Section 7.2.(b) above.
7.8.3 Significant Competitors in the Field of Passenger Aircraft Transport To the best of the Group's knowledge, the Group's major competitors in the passenger aircraft transport field, in terms of market share, are Continental (U.S.), Delta (U.S.), U.S. Airways (U.S.), Lufthansa (Germany), British Airways (UK), Alitalia (Italy), Air France – KLM (France and the Netherlands), Swissair (Switzerland), Transaero (Russia), and Aerosvit (Ukraine). See Section 7.1.10 above for details regarding the intensification of competition in the field in 2010.
7.8.4 Key Methods for Coping with Competition The Group acts in a number of venues in order to raise profitability, while preserving and increasing its market share and increasing its load factor: a. Conforming the schedule, as much as possible, to the seasonality of traffic and to international events.
b. Increasing the frequency of flights to popular destinations and increasing the number of
flight destinations, including by cooperating with other airlines.
c. Striving to constantly improve the service to passengers, including improvements to seat
comfort, food quality and variety, and flight entertainment, etc. focusing on business class.
d. Providing benefits to frequent flyers club members and to businesses belonging to of the
Group’s business desk.
e. Operating through all relevant marketing channels.
f. Approaching the traveling public through advertising campaigns in Israel and abroad.
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The positive factors that affect, or are likely to affect the Group’s competitive position include the following: a broad and varied flight structure; a distribution system dispersed widely throughout Israel; the existence of an attractive frequent flyers club; a formidable brand in the local market; high level of safety and security; schedule stability and on-time performance; conforming services to market needs and code sharing agreements with other airlines. The negative factors that affect, or are likely to affect, the Group's competitive position include the following: a geopolitical situation that significantly reduces the Group's opportunities to carry out Sixth Freedom Flights (indirect flights via BGN) as opposed to the expansion of Sixth Freedom Flights by foreign airlines; the possibility of appointing additional competitors as Designated Carriers in Israel to destinations to which the Group flies or to nearby destinations, especially in view of the Government's aforementioned decisions; the declaration made by the U.S. FAA to lower the State of Israel's flight safety rating to Category 2 and concerns regarding restrictions imposed by European aviation authorities (for further details see Section 9.11.2(h) below); the entry of low cost airlines; membership of foreign airlines in global aviation alliances (STAR, One World, SKY); regulatory changes and legislative restrictions applicable to the area of activity (for details see 9.11.2.(i)); excess capacity of competitors; the Group's reliance on distribution by means of agents as opposed to the growing trend of direct marketing via the internet; the absence of passenger activity on behalf of the Company not flying on the Sabbath or Jewish holidays and possible worsening of the economic, security and political situation in
Israel.
7.9 Seasonal Factors The Group's operations are seasonal and are concentrated in peak periods. High traffic of Israeli residents abroad occurs principally in the summer seasons and at holiday times, and the greatest traffic of tourists to Israel is principally in the summer season or approaching the Jewish or Christian holidays or vacation time in their countries of origin. The Group's peak operations are in the third quarter, when passenger volume in 2010 and 2009 was approximately 31% and 32%, respectively, of total yearly passenger traffic.
The following are data on the breakdown of the Group’s quarterly revenues from passenger aircraft24:
24 The Jewish holiday period, according to the Gregorian calendar, varies from year to year; this may have an effect on comparing quarterly operations between one year and another.
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Quarter Yearly (In (In Millions of Dollars) Millions of Dollars) Year January- April-June July- October- January- March September December December 2010 375.0 451.2 498.7 440.4 1,765.3 % of Area 21.2% 25.6% 28.2% 25.0% 100% of Activity 2009 305.4 363.7 443.2 377.2 1,489.5 % of Area 20.5% 24.4% 29.8% 25.3% 100% of Activity
7.10 Manufacturing Capabilities The accepted indices of output in the world of aviation as regards passenger aircraft are load factor25 and ASK26. At peak demand (August), the Group's productive capacity approximates full potential output. In August 2010 the Company’s ASK was 2,282 million RPK and the Company load factor for August 2010 was 87.6%. Note that the yearly load factor considered most efficient by leading regular international airlines is generally no greater than 80%. The following graph describes the monthly average ASK and the Company's average load factor over the past five years:
25 Passenger Load Factor-computed as RPK (number of paying passengers multiplied by distance flown) as a percentage of ASK (number of seats offered for sale multiplied by distance flown). 26 Available Seat Kilometer - number of seats offered for sale multiplied by distance.
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In accordance with the 1982 government resolution, the Company ceased operating scheduled flights on the Sabbath and Jewish holidays, and, accordingly, does not fully utilize its productive capacity. With the conversion of the Company to a “Mixed Company” on June 6, 2004, this prohibition was removed. Pursuant to an agreement reached in January 2007 between representatives of the Rabbinic Committee for Sabbath Observance and Company representatives, the parties agreed that the Company would continue to maintain the status quo which had existed up to then, according to which the Company does not carry out passenger flights of EL Al on the Sabbath and on Jewish holidays, pursuant to the 1982 government resolution. In light of the need that arises from time to time for flights to be carried out on the Sabbath, it was agreed that, prior to such flights, the Company would communicate with the Chief Rabbi, Shlomo Amar, to clarify Jewish doctrinal positions. Additionally, the parties formulated understandings concerning the refund of cancellation fees for portions of kosher meals, in the event that, as the result of the breach of this understanding, ultra-orthodox customers would be forced to cancel their flights. See Section 9.18.24 below for further details.
7.11 Aircraft Fleet As of a date immediately prior to the approval of this report, the Company makes use of 40 passenger aircraft (27 aircraft owned by the Group including a 747-400 airplane purchased by the Company, which joined the fleet in February 2011 as detailed below, 12 aircraft leased by the Group including a 737-800 that began service in the fleet in January 2011 as well as an additional leased aircraft that will join by March 2011). The Group's fleet of passenger aircraft was manufactured entirely by Boeing. As a result, El Al is dependent upon aircraft manufacturer Boeing for all matters related to the supply of aircraft parts, in the event of failures and findings occurring during regular maintenance (as a result of it being the aircraft's manufacturer) and engineering consulting.
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a. The following table itemizes the fleet of passenger aircraft owned by the Group, as of
December 31, 2010:
Type of Total Average Age Average No. Maximum Flight Range Cargo
Aircraft (in Years) of Seats (Nautical Miles)28 Capacity27
747-400 5 15.4 404 6,400 18.7
757-200ER 3 18.5 190 3,000 3
737-700 2 11.3 120 2,000 1.5
29 737-800 6 6.7 142 2,400 1.5
767- 2 26.9 192 4,800 10.6 200ER(CD)
ER(EF)767-200 2 20.5 191 6,200 12.1
30 777-200ER 6 7.6 279 7,300 22.4
Total 26 12.9 235
As detailed in (2) below, in February 2011 a 747-400 airplane joined the fleet of aircraft owned by the Company, so that the total number of aircraft of this model rose to 6.
Pursuant to the Company’s reports, due to material changes occurring in the aviation industry as since the signing of the agreement with Boeing for the purchase of 4 777-200ER aircraft in March 2008 (hereinafter: the "Agreement"), including the global crisis impacting the world's markets, and due to the impact of these changes on the economic, business and financial environment in which the Company is active, and after a reevaluation of the Company's existing fleet of aircraft and necessary adaptations to it, the Company contacted Boeing, which acceded to the Company's request, and on April 29 2010 the parties signed a letter of agreement to cancel the agreement and set the terms according to which the Company shall be entitled to
27 Cargo capacity of a aircraft full of passengers for a range where the required amount of fuel does not come at the expenses of useful cargo 28 The range is for a plane full of passengers without cargo 29 In 2009 3 737-800 aircraft were purchased by way of a financial lease, financed and guaranteed by ExIm Bank; see Note 3.d.3 to the December 31 2010 Financial Statements. 30 Three of the 777s were purchased using ExIm guarantees and therefore the legal formula states that the aircraft were first leased by the Company, with the Company retaining the right to purchase the aircraft at the end of the period in return for $1.
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make use of a sum equal to the advance payments paid as part of the agreements, this as a result of new aircraft purchase transactions in the coming years. A strong and extensive relationship exists between the Company and Boeing and the cancellation of the agreement was out of mutual understanding and in light of the good relationship between the parties. For details see Note 7a to the Financial Statements.
The following are purchasing transactions of Company aircraft carried out in the reported year up to immediately prior to the approval of this report:
On February 7 2011 an agreement was signed with aircraft manufacturer Boeing (“the "New Agreement") for the purchase of three new Boeing 737-900ER aircraft and two additional aircraft of the same model convertible to purchase options. In addition, the Company was granted the option to purchase two additional aircraft of this model (hereinafter: the “Model”). In the New Agreement the Company was granted conversion rights for other models as well as associated rights. The comprehensive value of the agreement is estimated at between $220 million and $325 million (respectively for four to six aircraft, as purchased in practice, without the option), and reflects an average market value of aircraft of this model and similar production year, in accordance with generally accepted industry aircraft prices list and subject to adjustments and investments (including the purchase of an additional reserve engine for the fleet) in accordance with the version agreed upon by the parties, including linkage of aircraft prices, using an agreed-upon linkage formula.
The payments for each plane will be made two years before each plane is delivered to the Company, or according to other payment options the Company may choose. Furthermore, the parties agreed upon conditions for the use of some of the advance payment. Note that the as of the signing date the Company has made advance payments for six aircraft to the amount of 1% of the purchase price and paid, upon the signing of the New Agreement, an additional advance payment for the aforementioned option, upon.
At this stage the Company has not yet reached a final decision regarding the transaction’s financing and the Company is considering its various options.
According to the New Agreement, the aircraft are expected to join the Company’s aircraft fleet between late 2013 and 2016. The aircraft are expected to serve the Company for short and medium ranges (Europe and other destinations) and shall replace narrow-bodied aircraft as per Company strategy. The aircraft shall be operated in a 162-70 seat configuration, divided into two services classes. Note that these are aircraft of a new and advanced model, with modern
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engines and advanced internal configurations. The agreement was approved by the Company's Board of Directors on March 22 2011.
In February 2011 an agreement was signed with the R.B. Leasing Company Limited for the purchase of a 747-400 passenger aircraft. The aircraft, manufactured in 1996, shall undergo renovation and adaptation to the Company's service, so that it will include 387 seats and serve the Company for medium and long-range destinations. The aircraft joined the Company’s aircraft fleet in February 2011.
These transactions have been conducted in accordance with the Company's El Al 2010 business strategy, as detailed in Section 9.15 below, which was adopted in 205. The Company is continuing with the implementation of the plan in question while making adjustments to general
market trends.
b. The following table details the fleet of aircraft leased by the Company, as of December
31, 2010:
Type of Total Avera End of Lease Average Additional Details Aircraft ge Age Date No. of Seats
737-800 5* 6.7 November 142 * As detailed below, in 2015** January 2011 a 737-800
October 2014 airplane joined the fleet of aircraft leased by the October 2015 Company, so that the August 2016 total amount of aircraft December 2016 of this model rose to 6.
** The option exists to return the aircraft in November 2013.
757-200 2 21.7 December 2011 214
May 2011
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ER767-300 4* 17.0 November 230 * As detailed below, in 2014** March 2011 a 767-300
November 2011 airplane is expected to join the fleet of aircraft April 2013 leased by the Group, so November 2015 that the total amount of aircraft of this model will rise to 5.
** The option exists to return the aircraft in November 2012.
Total 11 13.2 187
Leasing fees for the Company’s aircraft in this area of activity amount to $58 million in 2010 compared to $53 million in 2009 and $39 million in 2008. The following are details of leasing agreements for Company aircraft performed in the reported period up to a date immediately prior to the approval of this report”
(1) In May 2010 the Company signed a contract with the International Lease Finance Corporation to lease a 767-300ER aircraft for a period of 65 months. The aircraft was manufactured in 1997 and will feature 237 seats in the Company’s service. The aircraft entered the Company’s
service on July 11 2010. (2) In July 2010 the Company signed an agreement to revise and exercise its option to extend the
lease of a K.M.A.S. Aviation 757-200 aircraft, starting December 2010, for an additional 12- month leasing period. (3) In August 2010 the Company signed an extension and a revision to the lease for the 737-800 aircraft, manufactured in 2001, from the International Lease Finance Corporation (“ILFC”), with whom a memorandum of understanding regarding the aircraft in question was signed in May 3. The aircraft shall be leased for an additional 45 months. (4) In October 2010 the Company signed an agreement to lease a 737-800 aircraft (EKT) from Wilmington Trust Sp Services (Dublin) Limited, which holds the plane in trust for CIT Aviation Finance Limited, with whom a memorandum of understanding was signed in July 2010 regarding the aircraft in question. The agreement includes the aircraft’s lease for an
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additional 68 months, with an option to extend the lease by an additional 24 months. The aircraft was manufactured in 2006 and shall be reconfigured to the Company’s configuration upon receipt. The agreement was revised and the lease period extended due to the fact that the
delivery of the aircraft was pushed forward from March 2011 to January 2011. (5) In October 2010 the Company signed an extension and revision to an agreement to lease a 737- 300ER aircraft, manufactured in 1991, from Aerospace International CIT, for an additional 42 months with the option to shorten the additional leasing period to 18 months. (6) In October 2010 the Company signed an extension and a revision to the lease of the 737-800 aircraft manufactured in 2003, from RAIN VI LLC with whom a memorandum of understanding regarding the aircraft in question was signed on May 6 2010. The aircraft shall
be leased for an additional 5-year period with an option to shorten the additional lease period to 3 years. (7) In January 2011 the Company signed an extension and revision to the agreement to lease a 737-300ER aircraft (EAR), manufactured in 1995, from International Lease Finance Corporation for an additional 60 months with the option to shorten the additional leasing period after 36 months. (8) In February 2011 the Company signed an agreement to lease a 767-300ER aircraft from A. I. AWMS, a Delaware Statutory Trust, with whom a memorandum of understanding was signed in November 2010 regarding the aircraft in question. The aircraft is leased for a period of 78 months and an early departure option has been granted each of the parties after 54 months. The aircraft was manufactured in 2000 and will feature 223 seats in the Company’s service. The aircraft is expected to join the Company's aircraft fleet in late March 2011.
Maintenance In January 2010 a landing gear maintenance agreement was signed with Turkish airline Atlas Jet. The agreement includes the restoration of 4 sets of landing gear for Boeing 7576 aircraft, by replacing old landing gear with the restored elements. The Company listed revenues of $1.25 million as a result of the agreement.
The U.S. aviation authorities have required the Company to perform alterations on the fuel tanks of the Company's planes. The cost of the change amounts to a total of $9.3 million. The change must be carried out on one half of the aircraft by the end of 2014, with the end date for all aircraft set for the end of 2017. Over the course of 2010 the Company ordered 3 kits at a cost of $1.1 million to carry out the change on 3 aircraft. The kits are expected to arrive over the course of
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2011, and shall be installed in the aircraft after their arrival. Over the course of 2011 the Company is expected to order an additional 5 kits, to be carried out in 2012, at a cost of $1.8 million.
An agreement was signed with the Histadrut and with the workers’ representatives on August 15 2010 for expanding the responsibility of technicians authorized to carry out works in the field of work on the Company’s aircraft including the right to sign off for work (“Signing Mechanic”). This agreement grants flexibility in work management and better supervision of works carried out on aircraft. The agreement was signed for a 6-month trial period which was extended to March 31 2011. Negotiations are currently underway to include it was a permanent item in the work agreement.
The Company took responsibility for clearing the runway at BGN. As part of the qualification process, an exercise was held on the subject in summer 2010 led by the Maintenance and
Engineering Division.
8. Cargo Aircraft Field
8.1 General Information on the Field of Operations The following is a description of trends, events and developments in the Group's macroeconomic environment, which have, or are likely to have, a material effect on operating results or on the developments in the entire Group or in the cargo aircraft field of operations, regarding the following issues:
8.1.1 Structure of the Field of Activity and Changes Occurring Thereof There are four types of competitors in the cargo air transport market: airlines that carry cargo solely in cargo aircraft; airlines that carry cargo solely in the holds of passenger aircraft; companies, like El Al, that carry cargo both in cargo aircraft and in the holds of passenger aircraft; courier airlines which, in addition to cargo related to courier services, also carry other cargo in their aircraft. In recent years, a trend has increased among airlines studying the possibility of converting passenger craft to cargo craft primarily for economic reasons. The existing cargo plane in the Company's service is a Boeing 747-200 of a relatively advanced age compared to the aircraft fleet in general, and various limitations have been placed on its activity that harm its economic feasibility. As a result of the above he Company has been studying changes in its cargo fleet and operating plan (for details see 8.1.2 bellow). In addition, there is a relatively low global supply of designated cargo craft, and therefore the aviation market has come up with the solution of
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converting 747-400 passenger planes to cargo craft. This trend is reflected, inter alia, in the transition to passenger aircraft with greater cargo carrying capacity. Continuation of this trend could transfer cargo transport operations from the cargo aircraft field to the passenger transport field. According to the Company's estimates, the Group's portion of the cargo transportation market in 2010, 2009 and 2008 has been assessed at 34.2%, 33.0% and 32.9% respectively, out of all cargo transported to and from Israel by air (including cargo shipped in the holds of cargo craft. Not including Sixth Freedom and including mail activity).
8.1.2 Legislative Restrictions, Regulations and Particular Considerations Applicable to the Area of Activity In July 2009 the Company submitted a request to the Government Companies Authority for the consent of the holder of the Special State Share, as required by the Company's articles, to remove two 747-200 cargo aircraft from Company service. On the same date, the Company responded to several queries by the holder of the Special State Share on the matter of the Company's plans in this regard, but the State has yet to provide its consent. In November 2009 the public committee established by the Minister of Transportation and Road Safety in June 2009 to study the Israeli cargo transport industry and to study the state of Israeli airlines dealing in cargo shipping published its conclusions, the key points of which being that the State would study the cost of the minimal response for the security requirement for transporting cargo in times of emergency in order to reach a grounded decision regarding the State's response to the Company's query, that CAL's request to assist with guarantees would be studies (this under the stipulation of activation of aircraft capable of mobilization in times of emergency), and the section of the CAL operating license prohibiting it from entering into collaborative agreements would be revoked. Furthermore, the Committee saw fit to note that it saw nothing wrong in the existence of cooperation between El Al and CAL, insomuch as this leads to the existence of a fleet for transporting cargo in times of emergency without causing a material impact to competitiveness. In the event that the companies approach the Restraint of Trade Controller with a request for collaboration in the area of cargo shipping, the Committee recommends that approval shall be made conditional, inter alia, on the assurance of proper availability of emergency cargo craft. Subject to this, the Committee recommends that insomuch as Government ministry opinion is
required on the subject, the subject shall be considered. The committee added that the possibility of establishing an inter-ministerial committee headed by the Ministry of Defense and with the participation of the Ministry of Transportation, the
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CAA and the Ministry of Finance, to study specific issues pertaining to cargo transport, shall be considered. The regulatory restrictions for cargo transportation in cargo aircraft are similar to those applicable to passenger transport in passenger aircraft. For details see 7.1.2 above. Regulatory arrangements have also been set for the cargo field relating to a number of operational aspects, such as permissible flight capacity, responsibility of the air carrier for damages, flight safety standards, security and noise. See Sections 9.10.3 and 9.11 below for details. Nevertheless, the policies of the global aviation authorities in granting permits for cargo aircraft have tended to be more lenient than in the passenger aircraft field. The situation particularly affects the huge opportunity to carry out flights of cargo aircraft using Fifth Freedom and Sixth Freedom.
8.1.3 Changes in the Volume of Activity and Profitability of the Area a. (A) Volume of global cargo transported According to IATA data, the cargo transport field has grown over the past 20 years. According to IATA data, in 2009, as a result of the global economic crisis, a 10.4%slowdown was listed in global air transport of cargo (including in the holds of passenger aircraft). Starting from the third quarter of 2009, a process of emerging from the economic crisis and economic recovery has begun, mainly in developing Asian markets, which has accelerated the air shipping sector. In the second half of 2010 the air shipping sector returned to the level of activity it had reached prior to the crisis, thus pushing forward projections that predicted a recovery within two years. According to IATA estimates, 2010 saw a 20.6% increase in global airborne cargo shipping rates (including in the holds of cargo planes). In October 2010 IATA published its estimates according to which by 2014 an average annual growth (2010-2014) of approximately 9.3% is anticipated in global cargo air transport (including in the holds of passenger aircraft)31. IATA estimates that 2011 will see a growth at a rate of 5.6%. In December 2010 IATA revised its projection to a growth rate of 5.5% in 2010.
31 The IATA projection for 2014 refers to increases in the weight of cargo shipped in tons, without taking the distance flown (RTK) into account.
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The following table describes the development of airborne cargo shipping activity between 2006 and 2010, based on IATA data32:
Year Output
RTK33 (in Millions) Annual Change in RTK
(%)
2010 No data. No data.
2009 125,230 (10.2)
2008 139,435 (2.6)
2007 143,160 3.5
2006 138,320 4.6
b. Volume of Cargo Transported on Aircraft to and from Israel The following are data on cargo traffic to and from BGN over the past five years (the data includes cargo carried in cargo aircraft and in the holds of passenger aircraft)34:
Cargo Traffic through BGN (Thousands of Tons) for the Year Ending December 31
Change Change Change Change
from 2009 from 2008 from 2007 from 2006 2010 2009 2008 2007 2006
164 7% 154 (15%) 182 (9%) 199 9% 182 Exports
136 15% 118 (16%) 141 1% 139 3% 134 Imports
300 10% 272 (16%) 322 5%)( 338 6% 318 Total
Aircraft traffic through BGN listed a 10.1% increase in 201035 relative to 2009. The main reason for the increase in traffic is the recovery from the global economic crisis that began in Q3 2009.
32 2010 data has not yet been published. 33 Revenue Ton Kilometer - weight of paid flown cargo in tons multiplied by distance flown. 34 Source: the Civil Aviation Authority and the Company’s estimate, which includes the deduction of Sixth Freedom activity by El Al through BGN and the addition of El Al mail activity.
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In addition to Israeli cargo company CAL, the cargo capacity of foreign airlines included the cargo capacity of passenger flights and capacity in cargo flights by six airlines: FedEx (U.S.), MNG and Turkish Airlines (Turkey), EAT (Belgium), Royal Jordanian (Jordan) and Korean Air (Korea). Likewise, unscheduled cargo flights were flown through foreign companies, on an ad
hoc basis. Some 50.1% of total cargo traffic through BGN was transported in cargo aircraft, while the remaining traffic (49.9%) was transported in the holds of passenger aircraft (mainly wide-bodied aircraft). This data does not include cargo that the Group flew via BGN in the context of Sixth Freedom (flight from one foreign country to another via BGN) to the amount of36 Of 1 thousand tons, 0.5 thousand tons, 2 thousand tons, and 7 thousand tons in 2010, 2009, 2008 and 2007, respectively. The decrease between 2008 and 2009 in the volume of cargo flown by means of Sixth Freedom is the result, inter alia, of the discontinuation of El Al cargo activity to East Asia in 2008. In March 2011, in light of the increase in fuel prices, the Company decided to increase its fuel surcharge to $1.13 per kg for export cargo to Europe and $1.53 per kg for export cargo to the
rest of the world.
8.1.4 Developments in the Field of Operations' Markets, or Changes in its Customers’ Characteristics The Israeli market in the field of operations of cargo transport by cargo aircraft is characterized by high seasonal fluctuations, due to the relatively high importance of agricultural exports (carried out primarily in the winter months), out of total exports. See Section 8.5 below for information on the Company's customers in the field of cargo aircraft shipping.
8.1.5 Technological Changes that could Materially Affect the Field of operations The Company is working to expand and develop advanced IT solutions in the field of airborne cargo, in the field of online trade and in self-service abilities with the goal of improving service and reducing the Company's costs. A new system for the management of cargo transaction entered service in the second quarter of 2009, and use of the online ordering system was expanded. The system is intended to lead to improvements in commercial processes including in the areas of pricing, limitation of the amount of transactions, simplification of the transaction approval process, greater precision in attaching transactions to bills of lading, greater precision in customer billing and improvements
35 Without deducting the Company's Sixth Freedom activity by means of BGN, the rate of increase in traffic in 2010 was about 10.4%. 36 Data includes cargo that was carried in cargo aircraft as well as cargo carried in the holds of passenger aircraft.
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in service. In addition, completion of the project was expected to bring about work with a centralized operation system, improvement in the quality of information and improvement in the transparency of information on the network. The expectations were partially realized, due to the interface with the accounting system. In light of this, in November 2010 the Company issued an RFP for an off-the-shelf product supporting the commercial, operational and accounting processes (from the sales stage to accounting). The system is expected to allow the Company to support standards and installations in the air shipping industry. The system is expected to constitute an innovative and integrative base of information for the cargo yield management system.
The information regarding possible implications of the completion of the automation o f the accounting system and the improvement expected as a result to the Company's commercial processes represents forward-looking information, as defined in the Securities Law. The information is based in its entirety on the Company's estimates as of this report. Therefore, the actual implications may be materially different from those forecast, as the result of many factors, including technological factors, the Company's ability to implement the new system
and its actual implementation as well as changes in cargo aircraft activity levels
8.1.6 Critical Success Factors ion the Area of Activity and Changes Occurring Thereof A number of factors can be pointed to in the operations of the cargo transport sector via passenger aircraft that affect the field's competitive position: the ability to offer the transport of cargo to popular destinations at competitive prices; development of a network of routes on an independent basis, including the possibility of carrying out Fifth Freedom Flights and Sixth Freedom Flights, both as operations supporting transport to and from Israel; cooperation with other airlines; offering transport at the frequency and quality demanded while meeting time schedules; risk management and risk hedging.
8.1.7 Changes in the Supplier Network and the Raw Materials for the Field of Operations The primary raw material used by airlines is jet fuel, which represents one any airline's major expense components. See Section 9.5.1 below for additional details relating to fuel. In addition, as the Company's entire passenger plane fleet was manufactured by the Boeing Corporation, the Company is dependent upon this manufacturer for all matters pertaining to the regular maintenance of its aircraft, as regards parts and repairs.
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8.1.8 Main Entry and Exit Barriers of the Field of Operations and Changes that have Occurred Thereof The regulatory entry barriers (the need for appointment as Designated Carrier and the permits as to frequency, capacity, etc.) for scheduled flights in cargo aircraft are similar in essence to the regulatory entry barriers for scheduled flights in passenger aircraft. See Section 7.1.8 above and Section 9.11 below for details. The Company assesses that some countries have a more liberal policy of granting permits in the field of cargo transports. Therefore, in the Company’s assessment, this entry barrier is less significant for some countries in the cargo field. Another important entry barrier in the industry is the initial, relatively large investment that is necessary in order to establish and operate an airline, including acquisition of aircraft and other substantial current investments, including aircraft leasing. Under international aviation agreements, obtaining appointment as a Designated Carrier is conditional upon substantial ownership and effective control of the air carrier being held by the government or citizens of the country that has specified that it be a Designated Carrier. This requirement represents an entry barrier for obtaining appointment as Designated Carrier by foreigners. See Section 7.1.8 above for details on changes in this condition under the terms of aviation agreements of the State of Israel. The restrictions imposed by the holder of the Special Government Share in the matter of the reduction of the Company's cargo fleet constitute an exit barrier. See Section 9.11.1 below for further details.
8.1.9 Alternatives to Services of the Field of Operations and Changes that have Occurred Therein The principal alternatives to air transport in cargo aircraft are transport in the holds of passenger aircraft, maritime shipping or a combination of maritime shipping to the nearest destination port and from there, shipment overland. The Company estimates that the major considerations in selecting air transport over ocean and/or land transport are the nature of the product, the requisite shipping conditions, the necessary amount of time and the transport costs. In 2010, no material changes occurred in the alternatives to cargo aircraft shipping.
8.1.10 Structure of Competition in the Field of Operations and Changes that have Occurred Therein There has been a structural change in the industry in the Israeli market in recent years, due to increased sources available to customers with the entry of new airlines with cargo aircraft, inter
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alia, by means of the Fifth and Sixth Freedoms, upgrade of the passenger aircraft of the foreign airlines to broad-body planes capable of carrying more cargo in their holds and also by the entry of an additional Israeli cargo carrier- C.A.L. Cargo Airlines Ltd. (above and below: “CAL”). See Section 8.7 below for further details.
8.2 Services in the Area of Activity In this area of activity, the Group offers cargo transport services in cargo aircraft from Israel to destinations to and from Israel; cargo transported from one foreign country to another foreign country (Fifth Freedom), for example from Liège to New York; or cargo transported in the context of Sixth Freedom (indirect flights via stopovers in the home country of the airlines), for example from Asia to Europe or the U.S. with a stopover in Israel. The Group differentiates between three main destination groups: (1) North America; (2) Europe; (3) East and Central Asia. During the reported year, the services offered by the Group in this area of activity were cargo transport services to one destination in Europe, one destination in North America and one destination in East Asia. Moreover, the Company offers cargo services to many additional destinations by means of the Group’s passenger aircraft or by means of cooperative arrangements with other airlines and also by means of land transport from the airport. A process was completed on October 6 2008 in which European cargo activity was concentrated at Liège Airport, Belgium, which constitutes a single central hub as an alterative to cargo activity in three airports in the Benelux region. In April 2010 the Company entered into an agreement with JDR J.M.M. de Rijk BV (hereinafter: "JDR") for ground transport services of cargo to Europe for a 12-month period with an option to extend it by another period of time. JDR was selected as the chief transporter for ground shipping of Company cargo to various European destinations, in addition to managing the Company's transportation desk at Liege. In October 2010 the Company began operating a weekly flight to Hong Kong using its 747-400F cargo plane. The following is a breakdown of the volume of cargo traffic in the Group’s cargo aircraft, by principal destination category, in 2007 to 2010:
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Cargo Traffic in Group's Aircraft, by Region (Tons) For the Year Ending December 31
2010 2009 2008 2007
Israel to/from Europe 36,068 34,796 41,281 55,129
Israel to/from the U.S. 8,310 6,202 13,364 15,170 Israel to/from the 1,418 ------3,451 13,292 East and Central Asia Total 45,796 40,998 58,096 83,591
This data do not include cargo that the Group flew other than via BGN in the context of Fifth Freedom and cargo which the Group carried by air, via BGN, in the context of Sixth Freedom. The Group flew cargo using Fifth Freedom to the amount of 5 thousand tons, 3 thousand tons, 7 thousand tons and 21 thousand tons in 2010, 2009, 2008 and 2007, respectively. The Group flew cargo using Sixth Freedom to the amount of 0 thousand tons, 0 thousand tons, 1 thousand tons and 5 thousand tons in 2010, 2009, 2008 and 2007, respectively. The chief markets for cargo shipping services are for importers, industrial enterprises and the agricultural sector. The principal markets for cargo transport services are importers, industrial enterprises and the agricultural sector. On February 3 2010 the Company signed a framework agreement with Maman, which operates a cargo terminal at Ben Gurion Airport, regarding the receipt of terminal services from Maman. See 9.12 for further details
8.3 Analysis of Revenues and Profitability from Services In 2010 the Group's revenues from this area of activity increased by 50% compared to 2009 revenues, compared to a 15.8% decrease in cargo traffic through BGN in 2009. For information regarding the breakdown of the Company’s revenues and profitability (consolidated) by the Company's reported operating segments in the area of cargo aircraft shipping see Section a.5 of the Board of Directors report.
8.4 New Services From time to time, the Group studies the prospects of operating flights to new destinations and increasing the frequency of its flights to existing destinations, in accordance with market demands.
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8.5 Customers, Marketing and Distribution Most of the Group's sales in the field cargo aircraft shipping field are made through cargo agents (85.2% in 2010). The remaining sales are made directly to customers. In the field of transport using cargo planes, the Company does not have any customer from which the Group’s revenues amount to 10% or more of total Group revenues. In addition, the Israeli company for cargo consolidation (ACI), part of the shares of which are held by the Company (without the right to receive dividends), is engaged in consolidation of air cargo at BGN and its transfer abroad, mainly through the Company. ACI, like other airlines that operate in this field, consolidates the cargo of individual dispatchers into one shipment and, as a dispatcher, transfers it to El Al for shipment. In this way, it avoids interaction with a large number of dispatchers and cargo recipients, leading to cheaper air transport costs of consolidated shipments. In January 2011 the Company reached an agreement on the principles of the update of its agreement with Agrexco Agricultural Exports Ltd. (hereinafter: "Agrexco") for the airborne transport of agricultural export cargo, in order to preserve existing activity between the companies. The agreement was extended by one year, from December 2010 to November 2011.
8.6 Reservation Backlog In general, air transport of cargo in cargo aircraft is carried out near the execution of the service reservation. Therefore, the Group did not have a significant volume of reservations backlog during 2010.
8.7 Competition 8.7.1 Competitive Conditions in the Field of Operations a. The cargo aircraft transport field is characterized by strong competition between the airlines that supply transport services between the same destinations or alternative destinations. The airlines compete in different areas, mainly: transport rates, flight schedules and flight frequencies.
b. In recent years, the Civil Aviation Authority has tended to approve requests made by foreign scheduled airlines to increase the frequency of their flights to Israel. As a result, an increase has been apparent in the capacity of cargo shipping in the holds of passenger aircraft of
foreign airlines. This increase has led to intensifying competition in cargo shipping as well.
c. The significant increase in the flight capacity of regular foreign airlines referring to the passenger aircraft field of activity also led to a significant increase in cargo shipping capacity in the holds of passenger aircraft operated by regular foreign airlines to and from Israel. In
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light of indications of extraction from the economic crisis recovery in international passenger traffic, business and tourism, competition is expected to escalate in 2011 as well as a result of the entry of new foreign airlines, as a result of additional increased capacity and/or frequencies and destination expansion by existing airlines as well as the operation of scheduled flights to new destinations by other Israeli airlines. In light of the above, competition in the industry has intensified in the field of cargo aircraft activity.
d. Until 1999, the Company was the sole Designated Carrier of the State of Israel to most of the destinations to which it operates scheduled flights of cargo aircraft to and from Ben Gurion Airport. In recent years, other foreign airlines operating cargo aircraft have entered the field of operations in Israel. Starting 1999, CAL was given a full commercial operating license and, over time, was appointed as Designated Carrier to a number of destinations. CAL operates two 747-200 cargo aircraft, which it owns, and leases additional aircraft as needed. As of the date of the report, CAL operates flights to various destinations in the United States and Europe. The granting of a full commercial operating license to CAL led to a reduction in the Group's cargo operations. Previously, CAL had requested appointment as Designated Carrier to additional destinations to which El Al is the sole Designated Carrier, and as to which, under current aviation agreements, no more than one Designated Carrier may be
appointed.
e. In 2010 the Group competed for cargo transport in cargo aircraft to and from Israel with six foreign airlines (in addition to CAL), which operated cargo aircraft in flights to and from Israel. Korean Airlines once more began operating a unique cargo aircraft starting from April
2010 and starting November 2010 returned its second designated cargo aircraft to service.
f. An agreement was reached between Israel and Germany in January 2009 for 7 cargo frequencies per week for each side's Designated Carriers (compared to three frequencies to date). Following this, in March 2009 the Ministry of Transportation announced that CAL would be appointed Designated Carrier for cargo flights to Frankfurt and Cologne in
Germany, but CAL has yet to begin operating these flights.
The information regarding possible implications of such agreement regarding the scope of the Company's cargo shipping activity to Europe constitutes forward-looking information as defined in the Securities Law. The information is based entirely upon the Company's estimates as of this date. Therefore, the actual implication may be materially different from projections as a result of a large number of variables, including changes in the scope of activity in the field, realization of the agreement by the Designated Carriers for the
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Germany route to carry out flights to these destinations and the level of competition with
other competitors.
g. The Group competes with most of the scheduled airlines that operate passenger aircraft and carry cargo in their holds37. According to Civil Aviation Authority statistics, 49.9% of the air transport of cargo to and from Israel during 2010 was carried out in the holds of passenger aircraft (primarily wide-body aircraft) on scheduled flights, while the remaining cargo
(50.1%) was flown to and from Israel in cargo aircraft.
h. Lufthansa and Austrian Airlines merged their cargo departments starting July 1 2010.
8.7.2 Major Competitors in the Filed of Cargo Aircraft Transport To the best of the Group's knowledge, its most significant competitor in transport through cargo aircraft, from the standpoint of market share, is the CAL Company.
8.7.3 Key Methods for Coping with Competition The Group acts on a number of levels in order to raise its profitability, while retaining and increasing its market share and also increasing the volume of the cargo its transports as follows: a. Conforming their timetable, as much as is possible, to the seasonality of traffic and maintaining the timetable's stability.
b. Increasing the frequency of flights to popular destinations and increasing the number of flight
destinations by cooperating with other companies.
c. Offering competitive prices.
d. Adding to the frequency of the Company’s cargo flights between two foreign countries.
Positive factors that affect, or are likely to affect, the Group’s competitive position include leasing a designated 747-400 cargo plane; a strong brand name in the local market; a high standard of service, high safety levels; timetable stability and on-time performance.
Negative factors which affect, or are likely to affect, the competitive position of the Group include the possibility of appointing in Israel additional competitors as Designated Carrier or to additional destinations; regulatory changes that restrict the option of entering into agreements
37 In recent years, there has been intensification of a trend of transporting cargo in the holds of cargo aircraft. This
trend is reflected, inter alia, in the transition to passenger aircraft with greater cargo carrying capacity.
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with other airlines or prevent the utilization of flight rights; the entry of new, foreign competitors; increases in flight capacity of foreign airlines (including fifth and Sixth Freedoms); downturn in the economic, security and political situation in Israel.
8.8 Seasonal Factors The field of operations is characterized by high seasonal fluctuations due to the relatively strong influence of agricultural exports out of total exports by means of cargo aircraft. The following is data on the breakdown of the Group’s quarterly revenues from cargo aircraft:
Quarter Yearly (In (In Millions of Dollars) Millions of Dollars) Year January- April-June July- October- January- March September December December 2010 18.0 21.4 18.3 29.8 87.5 % of Area 20.6% 24.5% 20.9% 34% 100% of Activity 2009 19.2 11.9 12.0 15.2 58.3 % of Area 32.9% 20.4% 20.6% 26.1% 100% of Activity
8.9 Manufacturing Capabilities The generally accepted output indices for airborne cargo shipping using cargo aircraft are load factor.38 And ATK39. During peak demand (in 2010 – December), the productive capacity of the Group approaches its full potential output. In December 2010 the Group’s ATK was 37,313 thousand ATK with a load factor of 69.7%. Note that the load factor indicator is calculated based on the weight of the cargo only and does not take the volume of the cargo into account. [Monthly Average – in Millions of ATK]
38 Calculated by RTK (the weight in tones of the paid cargo times the flight distance) as a percentage of the ATK (the available cargo shipping capacity times the distance flown). 39 the available cargo shipping capacity times the distance flown.
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Monthly Average – in Millions of ATK
100 85%
80 80% 60 76% 76.40% ATK 75% 40 L.F 66.6 71.70% 71.70% 70% 20 39 22 26 0 65% 2007 2008 2009 2010
The following graph describes the Group’s average load factor and ATK index per quarter in 2010:
40 ATK monthly average (000,000) L.F. 90% 35 85% 36 30 80% 83.6% 72.1% 82.3% 75% 25 70% 20 24 23 21 71.1% 65% 15 60% 10 55% 5 50% 0 45% Q1-2010 Q2-2010 Q3-2010 Q4-2010
8.10 Aircraft Fleet As of immediately prior to the approval of the report, the Company makes use of two cargo aircraft – one Boeing 747-200 owned by the Company, and an additional leased Boeing 747- 400. An additional 747-200 owned by the Company is no longer in service due to the need for major maintenance works, which were not carried out by the Company. For the Company's request from the holder of the Special State share for permission to dispose of both of the cargo
craft in its possession as well as to lease a Boeing 747-400 cargo craft, see 8.1.2.
Note that in the past the Company received the approval of the holder of the Special State Share, in accordance with the provisions in the Company's bylaws, to reduce the Company's cargo fleet to two.
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a) The following table itemizes the fleet of cargo aircraft owned by the Group, as of
December 31 2010:
Type of Total Age (in Years) Maximum Carrying
Aircraft Capacity
747-200F 1 30.5 125 tons
747-200F40 1 30.5 125 tons
b) The following table itemizes the fleet of cargo aircraft leased by the Group, as of December 31 2010:
Type of Total Age (in Years) Maximum Carrying
Aircraft Capacity
747-400F 1 16.4 127 tons
On March 28 2010 the Company signed an agreement for the leasing of a Boeing 747-400 aircraft, manufactured in 1994, with Banc of America Leasing Ireland Co. Limited. According to the agreement, the leasing period is from the date of the aircraft's receipt until June 30 2012 with the option (held by the Company) to extend the lease for an additional 36 month period. In addition, pursuant to the agreement, the Company was granted the right of first refusal and options to purchase the aircraft, in accordance with the agreements between the parties. For details see Note 39c to the Financial Statements.
In addition, the Company leases cargo aircraft in “wet leases” (aircraft leased with its crew) as needed. As described above, the Company is acting to replace its entire 747-200 due to reasons of economic feasibility in operating the fleet due to the advanced age of the aircraft and the problem of complying with the maximum permissible engine noise restrictions in various airports worldwide (See Section 9.10.3 below for details of noise restrictions). Total leasing costs borne by the Company in this field of operations amounted to $681,000 in
2009 versus $660,000 in 2010.
40 The aircraft is not in use due to the need for major maintenance works.
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8.11 Raw Materials and Suppliers The principal raw material employed by the Company is fuel. See Section 9.5.1 for further details. In the cargo aircraft field, the Group, in its various stations throughout the world, engages suppliers dealing in unloading and loading aircraft, in cargo storage in warehouses and in land transport of the cargo from the customer to the airport and vice versa. The rate of expenses related to commitments with these suppliers 2010 accounted for some 14% of the operating sector’s expenses. The Group was not dependent on any single supplier in 2010.
9. Details Regarding Both Areas of Activity
9.1 Fixed Assets and Installations 9.1.1 Real Estate a. The Group owns an area of 1,560 square meters in the El Al Building on 32 Ben Yehuda St., Tel-Aviv, which serves as the offices of the Company's Israeli branch. The Group also owns offices in Spain (Madrid) and Argentina (Buenos Aires) with a total area of 269 square
meters.
b. The yearly cost for renting areas in Israel is $8,200,000 for built-up property 88,000 square meters in size (80,000 square meters of which is in the El Al campus). The following are
details of material real estate properties rented by the Group in Israel:
Contract Period Consideration Parties to the The Property and Option to Extend Agreement The agreement shall remain in $2,650,000 for the An authorization The El Al BGN campus effect until December 31 2010. ground and agreement between the has a built-up area of Furthermore, the option exists to structure Airports Authority (the 80,000 square meters on extend it for an additional 25- component for issuer) and El Al (the 29 hectares of land. year period. The Company 2010. recipient). See (c) below. announced its intent to exercise this option to extend in accordance with the agreement. The agreement was extended to Yearly usage fees An authorization The SLN warehouse at December 31 2012. to the amount of agreement between the BGN with a built-up $650,000. Airports Authority (the area of 2,600 square issuer) and El Al (the meters plus 1,750 square recipient). meters of operational grounds. See (e) below. Yearly usage fees An authorization Areas in BGN Terminal to the amount of agreement between the 3 – area for the King $4,500,000. Airports Authority (the David Lounge and other issuer) and El Al (the areas. See (d) below. recipient).
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The agreement was extended to Yearly usage fees Agreement between El Areas in BGN for its December 31 2011. to the amount of Al and Maman – Cargo cargo shipping activity, $140,000,000. Terminals and Handling which include the
Ltd. Maman Building compound, with a total area of 275 sq. meters. The agreements are for different Total yearly cost of Different owners in El Al branches periods. $220,000. conjunction with the throughout the country Company. with a total area of 600
square meters (not including 650 square meters of parking rented in various locations).
c. Land Usage Rights at Ben Gurion Airport (BGN)
Ben-Gurion Airport (BGN) serves as the Group's home port and main base of operations. The Group’s headquarters, hangars, aircraft parking areas, workshops, warehouses and other offices and installations are located at BGN. Most of the offices, hangars and other buildings used at BGN were constructed on land to which the Group has long-term usage rights.
Under the auspices of the agreement dated June 1992 with the Airports Authority (AA), as amended in February 1995, the Company holds usage rights (permit) to 29 hectares of land at BGN through December 31, 2010. This period may be extended for an additional 25-year period under the terms of the contract or under other terms as will be agreed upon with the AA. It appears that exercise of the option will be subject to the payment of Purchase Tax. The Company is currently negotiating with the Airports Authority regarding the extension in question.
According to the aforementioned agreement, the AA permits the Company to use the property and the access roads to it and also allows the Company to operate airline services on and/or through the property. The agreement gives the AA the right to demand that the Company vacate space and/or a building that it will need for the operations, safety, development or security of the airport.
In 2005, the Company paid $960 thousand in licensing fees for the aforementioned usage rights, and starting 2006 and thereafter, the licensing fees will rise by 7.4% per annum until the end of the contract period, not to exceed $4 million per annum. In accordance with an October 19 2004 amendment to the agreement, in addition to the payment for the land, the Company shall pay annual usage fees to the AA for certain fully depreciated buildings and installations. Payment is at a gradually increasing rate (according and subject to the amount and type of structures finishing the depreciation period each year, according to a depreciation period of 40 years from the structure’s construction. A sum of $2,650,000 was paid in 2010.
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d. Terminal 3
The agreement to provide a permit for operating a passengers’ lounge (1,500 square meters) was signed on December 11, 2006, and the Company had been operating the lounge since November 2004. The agreement will be in effect for 6 years starting November 2, 2004 at a total consideration of $2,350,000 per year, plus an extension option for another 3 years; recently extended to December 31 2011. Note that the yearly cost is revised based on the CPI and the index of El Al passenger traffic through BGN.
Furthermore, agreements to grant a permit for the other areas were also signed, covering a period of 10 years starting November 2, 2004, in return for rental fees amounting to $2,150,000 a year.
In the context of the operations of Terminal 3, the Group considered whether to set up an aircraft maintenance center adjacent to Terminal 3. For this purpose and in preparation for the move to Terminal 3, in April 2000 the Company signed an agreement in principle with the IAA to lease approximately 2 hectares in order to set up a maintenance center, a hangar and supporting facilities near Terminal 3. The IAA Board of Directors ratified the transaction but it is subject to the signing of a detailed agreement between the parties and the ratification by the Company's Board of Directors. As of these statements, no detailed agreement has yet been signed between the parties. The Company has received notice from the IAA stating that the IAA apparently cannot uphold the agreement and allow the Company to construct a hanger for large aircraft at the location decided upon. In light of this notice, the sides have been holding talks to find an acceptable solution.
Global Real Estate Rentals
The following are details of material real estate properties rented by the Group around the world: Category Area in Square Meter Cost in Thousands of Dollars The middle east 2,150 960 Europe 7,250 3,400 Britain 1,650 1,100 North America 4,100 2,500 Overall Rent paid 15,150 7,960 around the world
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Note that starting January 2011, the Company’s representatives in Paris have moved to new offices, after making an initial one-time investment of €250,000. Current rental costs are expected to reach €250,000 a year (compare to €450,000 in the previous offices).
9.1.2 Accessories, Spare Parts and Spare Engines The Company keeps accessories, spare parts and spare engines in its warehouses, with a total amortized cost of $97 million as of December 31, 2010. In recent years, the Company has begun to purchase external logistic support services from designated suppliers abroad to complement the spare parts purchased by the Company.
See Note 16 to the Financial Statements for additional details regarding fixed assets.
9.2 Insurance The Company’s insurance coverage is mainly related to two aspects: insurance of the different types of Company property and legal liability insurance for property and bodily injury. El Al’s airline liability insurance is limited to a ceiling of $1,500 million per occurrence, with the insurance coverage for third party damages from terror and war actions amounting to $1,000 million. According to the Company's estimates, this coverage suffices to provide the proper insurance protection for its operations. The hull all-risk insurance of the aircraft owned by or in the service of the Company, or as regards loss or damage to aircraft for which the Company has agreed to be responsible for insurance, is based on “agreed value” of each aircraft and includes deductible levels acceptable in the aviation industry. Insurance of aircraft hulls against dangers of war and similar risks covers, inter alia, acts of war, terror actions, civil war, strikes, riots, malicious damages, hijackings and confiscation. It should be noted that, at the request of Knafaim, the Company's controlling party, the Company entered into an agreement with it, according to which joint application was made to the Company's insurers. As of the report date, the Company's insurance policies include "contingent stratum" rider for 19 aircraft owned by the Knafaim Group leased to various airlines. The insurance is designed to insure the rights of the Knafaim Company in the event that the lessors or
their insurers breach their insurance obligations. The incremental premium for this rider amounted to $48,000 in 2010, and according to the agreement between the Company and Knafaim, Knafaim is responsible for this entire incremental premium, and also pays the Company an additional 15% of the incremental premium. Additionally, Knafaim undertook to be responsible for additional premiums that the Company may be required to pay, if and when such demand should be made.
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The Company is also covered by various insurance policies, which Company assesses are sufficient to provide insurance coverage adequate for the primary risks to which the Company and its employees are exposed. These refer to policies to insure employers’ liability, insurance of buildings against fire, earthquakes and the like, health insurance personal accident insurance for company employees, etc. The policies are renewed on a yearly basis. Group directors and executives are insured by director and officers' liability insurance in the framework of the insurance coverage prepared by Knafaim, in accordance with an agreement with Knafaim. See Section 29a of Chapter D (further details on the Corporation's activities) for details. The overall cost to the Company for insurance premiums during 2010 was approximately $9 million.
9.3 Intangible Assets The Group owns the “El Al” trademark, which constitutes the Group’s anchor brand, the Company’s name and logo design. A registered trademark is valid in Israel for limited periods fixed by law, and may be renewed at the end of each period. In addition, the Company also owns the trademark for "El Al" in the U.S. and in other countries around the world. In the Group’s assessment, the economic lifespan of the “El Al” trademark covers a multi-year period, being part of the Company’s name, and due to the many years that this symbol has been used and its dominant market position. Various internet domain names have been listed in the Company’s name in Israel and abroad, valid for variable periods of time, in accordance with registration rules in various countries, with an option to extend. See Section 9.11 below details as to licenses and flight rights given to the Group. For details regarding the Company’s rights to the use of security equipment see Note 17b to the Financial Statements.
9.4 Human Capital Organizational Structure Determination of the Company's general policies and supervision over the activities of the CEO are the responsibility of the Company’s Board of Directors. Day-to-day management of the Company’s affairs has been assigned to the CEO, who is assisted in his duties by the management team, serving as the Company head office, and comprised of the CFO, the VP of Maintenance and Engineering, the VP of Commerce and Aviation Relations, the VP of Human Resources and Administration, the VP of Services, the VP of Operations, the VP of Information
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Technology, the VP of Cargo, the General Counsel and Corporate Secretary and the Company Internal Auditor. For details regarding the CEO's terms of employment see Section 9.4.16 below. During 2010 and until the approval of this report, the following changes took place in the Company's head office: a) In August 2010 it was decided a new branch was to be established at the Company, the Planning and Organization Branch (P&O). b) In November 2010 the Customers Division was split into the Services Division and Sales Division, responsible for sales bodies in Israel and abroad – the direct sales center as well as the Israel Branch and regional branches responsible for overseas activity. c) In January 2011 the Company CEO decided that the VP of Cargo should head the Cargo Division instead of a department manager, as the case had been in the past. d) In February 2010 the South American department manager position was split from the West Europe department manager position (which had been responsible for South American activity until that date).
Ethical Code The Company has begun the process of formulating and writing an ethical code with the cooperation of employees and executives from the Company and its subsidiaries. An outside consulting company specializing in the issue was retained for this purpose. The code shall include an accepted list of values, behavioral norms, enforcement and implementation policies
and channels of communications for reporting violations of the code and of ethical guidelines.
The following chart describes the Group’s organizational structure:
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Board of Directors
CEO
Company The Company's Legal Council and Inspector secretary
Cargo VP Discounts Service World Man Power CFO Commerce Engineering Technology VP VP Sales VP and and Aviation and VP Administration Relations VP Maintenance VP
Head of the Head of the Head of the Head of Planning Operational Ground Head of the Head of the Head of the and and Operations Customer the Financing Income Head of the Organizatio Command Department Service and Human Departme Managemen Information Head of the n Department Sales Resource t System Aircraft Department Department s Department Department Head of Renovation Head of the the Department Israeli Head of the Budget Head of Head of the Head of the Technology Station Administration and the Air Israeli Infrastructure and Department Department Control Passenge Operations Branch rs Communication Head of the Department Department Marketing Department Treasurer Workshops Head of the Head of the of the and Logistics Head of Flight Instruction Company Department Head of the Service Head of the and the Time Security Department Business Organizational Table and Department Department Development distributio Department n systems Head of the Departme Aircraft nt Head of the Head of the Maintenance Head of the Business Acquisition Department Safety and Department and Alliance Head of Quality Department Department International Relations Head of the North and Head of the Department Central American Security Engineering Department Chief Department Head of the Head of the European Officer Commercial Department Head of the South Planning American Department Head of the Inspection and Quality Control Department Department
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9.4.2 Employees On December 31 2010 the Company employed 5,964 employees, 3,814 of them on a regular basis [337 of them in the Company’s overseas offices (including 24 Israelis posted abroad)] and 2,150 temporary employees (116 of them overseas).41. The following are details of regular and temporary employees as of December 31 2010 and December 31 2009:
Position December 31 December 31 2010 2009
Regular employees 3,814 3,733
Temporary employees 2,150 2,074
Total employees 5,964 5,807
The fierce seasonality of the industry requires modulation of personnel, which is carried out, according to demand, through a variable number of temporary employees. Personnel employed by the State also work as part of the Group’s security system, and the Company pays one-half of their salaries (in accordance with the splitting of security costs between the Company and the State - see Section 9.11.12 below for details).
The following is the breakdown of the Company's permanent employees in Israel and abroad as
of December 31 2010 and December 31 2009, according to their fields of employment:
41 The distribution of temporary employees by areas of activity is as follows: flight attendants (988), ground and service operators (617), maintenance and engineering (121), marketing, sales and cargo (26), overseas (116) and the remainder (223) in other positions.
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Position December 31 2010 December 31 2009 Senior employees 45 45
Marketing, sales and cargo 450 458
Pilots and flight engineers 505 523
Flight attendants 394 385
Ground, security, control, 604 596 operations and service operators.
Maintenance, renovations, 1,171 1,101 engineering and inspection
Auxiliary services 644 626
Total regular employees42 3,814 3,733
9.4.3 Material Dependence on a Specific Employee. The Company has no material dependence on any specific employee and/or executive.
9.4.4 Investment in Training and Instruction The Company’s training center has been certified as a “Qualification Institute” according to the Aviation Regulations (Inspection Institute, Qualification Institute and Self-Maintenance), 1979. The center trains workers and holds training courses for most of the professions needed by the Group: pilots, flight engineers, aircraft technicians, flight attendants, traffic officers, ground stewards, reservations and ticketing personnel, marketing and sales managers, junior management, etc. In addition, the Company holds courses and study programs for travel agents and cargo agents in Israel and abroad. Other than its activities in the training center, the Company assists its employees in acquiring technological schooling and higher education. The Company also sends employees to study programs and professional and management courses abroad and in Israel as well as studies for an academic degree. The Company invested some $9 million in employee instruction and training in 201043.
42 Includes 1st Generation and 2nd Generation (next generation) employees. 43 These costs include the direct training budget, payments for simulator practice, including related expenses, and the salaries of employees during their training period.
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9.4.5 Employee Compensation Plans a. See Section 3.3 above for details of the rights of employees and of the Company to purchase shares from the State.
For details regarding option plans for Company employees and executives – see 3.2 above and Note 30.g.1 to 30.g.5 to the December 31 2010 Financial Statements. On April 30 2009, the Company’s Audit Committee and Board of Directors approved a private allocation of 4,650,000 options to the Chairman of the Board of Directors. The option allocation and the terms of the employment of the Chairman of the Board were approved in the general meeting of the Company’s shareholders held June 24 2009. For details see Note 30.g.6 to the December 31 2009 Financial Statements.
On January 6 2010 the Company’s Audit Committee and Board of Directors approved a private allocation of 9,914,382 options to the Company's CEO. For details see Note 30.g.7 to the December 31 2010 Financial Statements.
9.4.6 Exemption from the Budget Fundamentals Law The Company’s request for exemption from Section 29 of the Budget Fundamentals Law was approved by the Minister of Finance, and was ratified by the Knesset’s Finance Committee on March 17, 2005.
9.4.7 Special Collective Agreements In addition to labor legislation and extension orders, the terms of employment of Company personnel employed in Israel, with the exception of the executives and other personnel employed under personal agreements, are organized in special collective agreements which are signed from time to time between the Company and the New General Workers Histadrut (above and below-the “General Histadrut”) and also by procedures that are occasionally issued by management. In early 2010, the pilots employed by the Company announced that they had left their employee organization – the New Histadrut – and had become members of a different organization, the
Israel National Workers Histadrut (hereinafter: "The National Histadrut"). The National Histadrut filed a petition before the National Labor Court that it recognize the pilots as a separate bargaining unit at the company, and as a result rule that the National Histadrut constitutes their sole representative. The Pilots' Union, which was added as a respondent to the proceeding, supported this position. The position of the General Histadrut and that of the employees' representatives, added as respondents, was that according to the collective agreement applicable to the relationship
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between the Company and its employees, it was agreed that all Company employees constitute a single bargaining unit and that there is no justification to recognize of the pilots as a separate bargaining unit. A hearing was held before the National Labor Court on March 8 2010 and on May 2010 2 a verdict was issued stating that the Company's pilots do not represent a separate bargaining unit and that the National Histadrut was not the pilots' representative workers' organization. In September 2010 the Company signed a collective agreement with the New General Workers’ Histadrut, Professional Union Branch – Transportation Workers Union, the Pilots’ Union, via representatives of the El Al pilots’ sector, dealing in various agreements pertaining to the Company’s flight crews, including the operation of a Boeing 747-200 cargo plane, extending the pilot transfer period from one fleet to another and so on. The following is a concise description of the main collective agreements, applying to the Company and its employees. a. Special Collective Agreement for Permanent Company Employees (“1st Generation Agreement” or the “Collective Agreement”) The special collective agreement applies to all of the Company’s permanent employees in Israel, including air crews. The agreement does not apply to senior employees (executives and others), who have personal employment agreements, nor to temporary employees who have their own special collective agreement. The agreement regulates all of the terms of employment of the permanent employees, and stipulates, inter alia, work procedures, basic rights and obligations, productivity incentives44, appointments and stationing abroad, internal tenders, insurance, pension arrangements, dismissal procedures, response to disciplinary violations, rights to free and discounted airline tickets and a conflict resolution apparatus. The agreement forbids strikes and sanctions, unless the strike has been declared by the Histadrut in compliance with the Law for Settling Labor Disputes, 1957, and subject to the Histadrut constitution, including a vote by all employees via secret ballot. According to the agreement, all permanent Company employees are ranked based on an enterprise wage ranking, which has no connection to national rankings. There are a number of rankings: ground employee ranking; “veteran” air crew personnel ranking; a separate ranking at lower wages for “new” air crew personnel; “veteran” flight attendant crew personnel ranking and a separate ranking at lower wages for “new” flight attendant crew personnel.
44 See Note 23.b.(2) to the Financial Statements.
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On November 2 2008, the collective employment agreement was signed by the Company, the employees' representatives and the Histadrut ("the Agreement"), after the Company's Board of Directors ratified the agreement on October 27 2008. The key points of the Agreement are as follows:
The Agreement shall remain in effect until December 31 2012.
Industrial peace and discipline - a commitment exists to uphold industrial peace for the duration of the agreement, while focusing on competition and growth challenges. The Company, the Histadrut and the employees' representatives shall conduct joint activities to promote and maintain order and discipline in the Company. The Company's authority as regards the termination of employees guilty of severe disciplinary violations shall be
expanded.
Bonuses and pay raises – when the Company becomes profitable, a general pay raise shall be granted equal to 3% of their pension salaries. In the event of profits greater than $10 million, employee shall receive a one-time bonus equal to between 18% and 24% of their base pay. In addition, in the following year, if the Company earns over $10 million, an addition raise equal to 1% of pension salaries shall be granted. If the Company earns over $35 million, an additional 0.5% shall be added to salaries. In the following year, if the Company earns over $10 million, an additional 1% shall be added to pension salaries. If the Company earns over $35 million an additional 0.5% shall be
added.
Horizon promotion bonus – when the Company becomes profitable, an annual budget for the financing of a horizon promotion bonus for non-promoted ground personnel as well as for flight crews and flight attendants with similar status. Non-promoted employees are workers who have spend many years at the top step of the existing
standard pay scale and are not designated for promotion. Work cessation – initiated retirement and/or work cessation of 30 employees via a process including work cessation pathways using an increased compensation format, early pension or a choice between the above (in accordance with the retiring worker's age).
Shifts and rest periods – shifts in Israel, station and maintenance, shall be adjusted and reinforced according to activity loads. Rest periods for pilots and regular and temporary
flight attendants in North America shall be shortened.
Special tracks and promotion – temporary employees with over 3 years seniority may participate in bids for entry-level managerial positions. The Company shall be permitted
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to employ up to 40 employees via personal contracts. Employees in the flight technician
field shall receive tenure after their fourth year instead of their second.
b. Special Collective Agreement for the Employment of Temporary Personnel (the “Temp Agreement”) The terms of employment of the temporary employees have been arranged in a special collective agreement that, on May 20, 2004 was extended to December 31, 2008. The agreement stipulates the maximum length of employment of temporary employees, in accordance with the type of work and the department in which the worker is employed. The agreement regulates all of the terms of employment of temporary employees, including wages, bonuses, provisions for comprehensive pensions, insurance, sick leave, rights to airline tickets, etc. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012. As special collective agreement pertaining to temporary flight attendants and temporary employees in the administrative sector was signed in February 2011. According to the agreement, a special reserve of 150 employees from each sector shall be established, who shall remain employed for an additional period of up to ten years as temporary employees. The working conditions of these employees shall be equivalent to full-time second generation workers, with the exception of the education fund. These employees shall adhere to the second generation employee disciplinary code. Dismissal of such employees due to incompatibility shall be via a consensual on par committee or following arbitration. The agreement shall remain in effect for three years with the option of extending it by an additional two. Note that most of the Company’s service personnel are employed as temporary workers and this agreement constitutes a significant milestone in aspects of service quality and is expected to reduce personnel turnover, increase profitability with the aim of achieving service excellence, as a material value in the Company’s approach. c. Special Collective Agreement for the “Permanent” Next Generation The agreement was signed on May 20, 2004 with regard to the administrative, commercial and operational professions, including supervisory and management, flight attendant and academic positions in administrative professions. This agreement regulates the terms of employment of the personnel, which are different than those applying to the 1st generation employees, with a saving in future costs and achievement of managerial flexibility, including the dismissal of employees due to lack of professional or operational suitability.
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The agreement was extended as part of the Special Collective Agreement on November 2
2008 to December 31 2012. d. Special Collective Agreement (Ground Crew- “Permanent Intermediate Generation”). The agreement was signed on May 20, 2004. It pertains to employees who began working prior to January 1, 1999 and is intended to apply different terms to them than those stipulated in the agreement for 1st generation and than those stipulated for the Next Generation. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012. e. Special Collective Agreement (Air Steward Crew Personnel -“Permanent Intermediate Generation”). The agreement was signed May 20, 2004, and pertains to flight attendants who began their employment prior to September 1, 1996 and flight attendants who commenced employment between January 1, 1996 and December 31, 1997, and is intended to apply different terms to them than those stipulated in the agreement for Generation A and for those stipulated for the Next Generation. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012. f. Special Collective Agreement (Securities) The agreement was signed on May 20, 2004. It obligates the Company to act to create balance among all personnel whose employment is organized by special collective agreements (Generation A, Interim Generation, Next Generation), in order to avoid the preference of one field over another and also regards granting future wage increments to different fields. The agreement stipulates, inter alia, that the number of permanent employees in certain professions may not be less on various dates than those stipulated in the agreement. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012. g. Special Collective Agreements for Ground Crews and Air Steward Crews (Shortening Stay Over) In July 2006 and in July 2007, a number of special collective agreements were signed between the Company and the New General Workers Histadrut - the Division for Professional Unions and the employees' representatives, relating to ground crews and flight attendant crews for improving the Company's operational flexibility by removing existing restrictions on direct flights without any intermediate stopover and shortening the stay of the crews in North America. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31 2012.
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9.4.8 Pension Arrangements The Pension Agreement Beginning September 1992, the social rights of part of the Company’s employees have been regulated within the context of a pension agreement. Pursuant to this agreement, an employee joining the comprehensive pension must insure a portion of his salary in the pension plan and the balance can be directed to executive insurance or to the provident fund of the Company's employees. After the agreement was signed, new employees must be insured by the comprehensive pension. The agreement stipulates that the Company's payments to the pension fund and an approved fund (executive insurance or provident fund) for an employee joining the pension plan, will come in lieu of its severance pay obligation to that employee, pursuant to Section 14 of the Severance Pay Law, 1963, for that part of the salary and for that period as to which the payments were made. Up to the joining date, the employee is entitled to severance pay based on his last salary. During 2005, amendments were made to the Income Tax Regulations (Rules for Approving and Managing Provident Funds), which change the rules for deposits and withdrawals of monies in pension insurance plans, inter alia, with regard to the reduction of the maximum amount which may be insured in capital insurance. In June 2005, the Company, the Histadrut - the Federation of Trade Unions and the Employees' Association of El Al Employees signed a special collective agreement that enables the adjustment of the provisions to the new rules, as selected by the employees. Executive Insurance Agreement The agreement between the Company and the Phoenix Israeli Insurance Company Ltd., which became effective December 1, 1990, was extended until the end of the effective period of the executive insurance policies that were issued under its auspices to employees. According to the stipulations of the pension agreement, redirecting part of the pension salary to executive insurance is conditional upon joining comprehensive pension. Executive insurance may be considered solely a savings plan or a savings plan with specified insurance (insurance against work disability and/or life insurance). The insurance provisions are at a rate of 18 1/3% of the insured salary, of which 8 1/3% is for severance pay and 5% for provident fund on the employer’s account and 5% for provident fund on the employee’s account. The Severance Pay Deficit and the Manner in which it was Covered Until the pension agreement was signed, Company personnel employed in Israel who were covered by the collective agreement had no pension insurance.
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According to the provisions of the collective agreement, since January 1983, the Company has made deposits (for employees who did not join the pension) of 8 1/3% of the current wages of the employees in a provident fund for severance pay in Israeli banks. The deposits are in the Company’s name. Since the Company did not deposit monies for severance pay in a severance pay provident fund until January 1983, and since January 1983, severance pay was paid to retired employees from the money accrued in the provident funds for severance pay, a substantial shortfall was created in the provident fund for severance pay, as listed in the table below (see Note 23.b. (3) to the Financial Statements on this matter). In addition, the Company’s books include an actuary liability in accordance with International Accounting Standard 19 for a grant for unutilized sick days. The grant is paid according to the provisions of the collective agreement at the time of retirement from the Company due to disability or age, or subsequent to a period of service, on the condition that the employee is entitled to severance pay. The liability is in accordance with the eligibility accumulated by the employees, as listed in the following table, and subject to the maximum ceiling for the redemption of sick leave, as detailed in Note 23.b.(4) to the Financial Statements. In addition, an actuary liability for accumulated vacation days is listed in the Company's books. The following are details of the Group’s net liabilities due to employee benefits (Consolidated data in thousands of dollars)*: December 31 December 31 2010 2009
Net post-employment benefits for 13,512 14,580 retirement and termination compensation, pension funds, sick day redemption and retiree benefits
Long-term benefits due to seniority 4,341 3,410 bonuses
Net benefits due to consensual 10,121 14,350 retirement plans
Less – current liabilities (1,183) (1,007)
Short-term benefits due to vacations 53,514 48,580
and others
Total 80,305 79,913
* The data featured in the above table does not include wages and associated (current). For further details on employee benefit liabilities see Note 23 to the December 31 2010 Financial Statements.
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In June 2003, an agreement was signed between the State, the Company and the employees’ association, according to which the State and the Company agreed to act to cover the deficit between the provisions for severance pay recorded in the Company’s accounts (the “Provision”) and the monies actually deposited into the severance pay provident fund (the “Fund”) and which is connected to the eligibility of employees who had been employed by the Company at the date that the Company entered receivership in 1982 and who continued to be employed in June 2003 (the "Eligible Employees"). On the date of the agreement, the deficit amounted to at 516,240,000 NIS, is index linked and bears annual interest of 5.05%, starting June 1, 2003. Under this agreement, the State and the Company transferred the immediate proceeds which they received from the sale of securities in the pursuant to the 2003 Prospectus (the “initial offering”), less expenses, to the severance pay fund for the eligible employees (the balance of the severance pay funds includes the above proceeds). The State and the Company also undertook to transfer to the severance pay fund of the eligible employees, any amount that was raised from the conversion of convertible securities that were issued in the initial offering or from the sale of securities in other offerings which would be executed through the date of the end of the last exercise date (June 5, 2007). From January 1 2007 through December 31, 2007, deposits were made to the severance pay funds of eligible employees: state deposits totaling 104,624,444 NIS, Company deposits of 100,862,605 NIS and in total deposits were made to the severance pay fund of eligible employees to the amount of 205,487,049 NIS. After making the above State and Company deposits, the deficit in the fund for eligible employees, as defined in the agreement between the Company and the State signed on the eve of the Company's privatization, was covered. After making the above deposits and fully covering the deficit in the severance pay fund, as required by the agreement, the Company deposited 30.3 million NIS (including interest accrued as of the reporting date), representing the balance of the offering proceeds, in a separate account (included in short-term deposits as of December 31, 2010 – see Note 6 to the Financial
Statements). As part of the restatement of the Financial Statements on December 31 2007, the capital reserve from transactions with a former controlling party was reduced in return for a liability listed to the State of Israel. The Company is assessing whether limitations exist to its ability to use said balance of the proceeds, pursuant to the agreement between it and the State, and in this context, it has requested a response from the General Comptroller of the Ministry of Finance. As of this report, negotiations are taking place with the General Comptroller’s Office at the Ministry of Finance in order to examine entitlement to issue surpluses.
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9.4.9 Legislative Amendments Pertaining to Retirement Age and Retirement Arrangements Maternity Leave Extension
On March 22 2010 Amendment 46 to the Women’s Labor Law, 2010 was published, stating that maternity leave for employees shall be extended to 26 weeks (instead of entitlement to 14, as was the case before the amendment), subject to the fact that prior to leaving for maternity leave the employee had been employed for at least 12 months by the same employer or at the same workplace. The employee may shorten the maternity leave, so long as it is no shorter than fourteen weeks. The entitlement to maternity pay from the Social Security Institute remains in effect, and it is limited to a period of just 14 weeks. In light of this, the extension of the maternity leave does not create an obligation for the employer to make provisions for the employee for the period. In the event that the employee is entitled to extend her maternity leave on the basis of one of the reasons set in law (the mother’s hospitalization during the maternity leave period, multi-child births, the child’s hospitalization during the maternity leave), the extension shall be added and granted past the birth to the period in question. The amendment also includes changes in rights to absence without pay following the maternity leave.
Transfer of the Burden of Proof to the Employer in Work Discrimination Suits Amendment 15 to the Equal Opportunity at Work Law, 2010, came into effect on July 7 2010, transferring the burden of proof in discrimination suits to the employer. The Equal Opportunity at Work Law forbids discrimination as a result of sex, sexual orientation, personal status, pregnancy, fertility treatments, in-vitro fertility treatments, parenthood, age, race, religion, nationality, country of origin, views, political party or reserve duty (Section 2(a) of the Law). This prohibition of discrimination applies to hiring, working conditions, advancement, training or professional education, dismissal or severance pay, benefits and payments given employees pertaining to retirement from work. The amendment means that from now on, in the event that a suit is filed by an employee or candidate due to the violation of the Equal Opportunity at Work Law, which proves that the employee or candidate was required, directly or indirectly, to provide information pertaining to the discriminatory issues detailed above, the burden of proof shall be passed on to the employers, who shall be compelled to prove that they did not act in violation of the law, and that the information they required from the employee or the candidate bore no weight or meaning pursuant to the decision made in their regard. The above Amendment 15 also applies also to the Persons with Disabilities Equality Law, 1998, with requisite changes.
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Expansion of Dismissal Prohibition during Fertility Treatments Amendment 45 to the Women’s Labor Law, 1954 passed on January 25 2010. Prior to the amendment in question, the prohibition of (unpermitted) dismissal set in the Women’s Labor Law applied, at least according to the letter of the law, solely to employees missing work as a result of fertility treatments, and under certain circumstances. The amendment expanded the prohibition to employees who were not absent from work due to fertility treatments, under various conditions and in various periods, as set in the amendment.
Provident Deposits According to the Comprehensive Pension Insurance Expansion Ordinance and Deposits in the Central Compensation Fund Starting January 2011, the rate of provident deposits increased in accordance with the Comprehensive Pension Insurance Expansion Ordinance, reaching 3.33% – employee deposits, 3.33% – employer deposits to provident funds and 3.34% – employer deposits to severance compensation. Furthermore, starting 2011 to option shall exist make deposits in a central compensation fund, meaning that compensation deposits may only be deposited in personal compensation funds, which are compensation funds that do not pay a stipend.
General Collective Agreement to Increase the Minimum Wage in the Israeli Economy On February 2 2011 a collective agreement was signed between the Coordination Office of the Economic Organizations and the Histadrut, according to which the minimum wage would be revised in two pulses – starting July 1 2011 the minimum wage shall amount to 4,1000 NIS and starting October 1 2012 the minimum wage shall amount to 4,300 NIS. The agreement is contingent on a respective amendment to the Minimum Wage Law or on the issue of an expansion order to this agreement.
9.4.10 Eligibility for Flight Tickets According to IATA regulations, Company employees are entitled to service-vacation flight tickets (free or at a discount), the great majority of which are on an available seat basis for themselves and for their families, including retired employees. This right is anchored in the labor agreements (and in the personal employment agreements of the senior executives), in the personal retirement agreements, in the Company procedures and in the professional instructions of the human resources division. The quota of free or discounted flight tickets is limited by the provisions of the labor agreement, of personal agreements or retirement agreements and by Company procedures. The Company included a provision in its December 31 2010 Financial Statements for the anticipated cost to the Company from the utilization of flight tickets by
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employees after retiring from the Company. For details regarding the agreement with Income Tax regarding deductions due to employee flight tickets see Section 9.9.6 below as well as Note 28f to the Financial Statements.
9.4.11 Employees Voluntary Early Retirement Plans Within the framework of its efficiency and cost-cutting measures, the Company has created voluntary early retirement plans. During 2009, 2008, 2007, 2006 and 2011, 8 employees, 31 employees, 52 employees, 95 employees and 11 employees, respectively, retired within the context of the retirement plans. During the period between 2006 and the date of the report, 197 employees have retired in the context of early retirement plans. For further details see Note 23e and 32.e.2 to the Financial Statements. In order to carry out the retirement plans, agreements were reached between the employees and the Company, between the employees and financial institutions, and between the Company and financial institutions. In the framework of these agreements, the financial institutions serve as the payer, making the pension payments to the retirees. As security for the Company’s obligations to the retirees, the State provided guarantees, according to which, inter alia, the Company will make periodic deposits (mostly, for one year in advance) to the financial institutions or will pledge a deposit in a commercial bank, at a sum identical to the total sums that the Company must pay as pension to its retirees for the coming year, and the Company’s payments to the retirees will be made from these monies. From time to time, the financial institutions estimate the anticipated costs of the retirement plan, and the Company updates its estimates to the extent necessary, according to actual costs and the experience gained on the subject. As of December 31, 2010, to secure the voluntary retirement plan for employees, the Company furnished guarantees to third parties totaling
$4,735,000. For details see Note 26c to the Financial Statements.
9.4.12 Local Employees at Company Branches Abroad Most of the Company personnel overseas, other than Israeli employees posted overseas, are employed according to collective labor agreements between the Company and the local union in that country, or according to agreements with the employees’ association, or according to agreements between the employers' organization (foreign airlines) and the umbrella organization of airline employees, or according to other agreements. The terms of employment of Company employees in the remaining countries are not covered by any collective agreement, but are established by the Company, in accordance with generally accepted practice in the aviation industry or in the national airlines in those countries. In some branches, the employees
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are employed through personal contracts or through a contractor. Some of the branches are committed to pay severance pay in accordance with law or contract; some of the branches have a pension insurance obligation or a right to pension by agreement. The Company makes regular payments for pension insurance and includes a full provision in its accounts for the liability for severance pay. An extension was signed to the agreement with the U.S. trade union on February 15 2011 for the period between January 1 2011 and December 31 2013.
9.4.13 Israeli Employees Posted Abroad The Company employs abroad, among others, permanent workers, consisting of Israeli residents dispatched to fill managerial positions abroad (“posted’). As of December 31 2010, 24 employees out of all of the Company's overseas employees (337) were Israelis posted abroad. Similar to State emissaries abroad, the salaries of those posted during their service abroad (hereinafter “Salary Abroad”) are also different from Israeli salaries, considering the standard of living and taxation abroad, and also the fact that the salary is subject to income tax and social taxation, both abroad and in Israel. The salary abroad, including participation in car maintenance, is paid to the posted employee based on “net salary” (taxes, including social taxation and the grossing-up abroad, are paid by the Company). If the salary abroad or special payments in excess of the tax-exempt ceiling are subject to tax in Israel, the Company assumes the Israeli tax. In addition to the salary abroad, the Company also bears the rental costs of those posted as well as tuition expenses for their children. These payments (up to a certain ceiling) are tax-exempt in Israel, but are liable for tax according to the laws of the different countries. The Israeli salary of the posted employee (salary according to rank and position, had they been employed in Israel) serves as the determining salary by the Company for the purpose of making provisions for severance pay, for compensation (or pensions and or executive insurance) and to an advanced education fund, as is stipulated in the posting letter.
9.4.14 Welfare Services and Payments In addition to salary, some of the Company’s permanent employees also receive welfare services and payments, which include: subsidized meals for employees and gross-up of related taxes, medical examinations of employees, participation in medical and health care insurance and dental insurance for employees, clothing, uniforms, and partial participation in higher education. Some of these benefits are also given temporary employees.
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Employees may, under certain conditions, receive guarantees for loans for various purposes. The loans are for periods of up to 60 months and are provided by the Company and Bank Yahav on terms that have been approved by the Ministry of Finance. See Note 13 to the Financial Statements for details.
9.4.15 Restriction on Leasing Aircraft via "Wet Lease" According to a letter dated December 1999 from the Company’s CEO to the Chairman of the Division for Professional Unions of the Histadrut, the Company is to restrict itself in the future to leasing up to 4 aircraft from Israeli airlines, so that the flight hours that will be executed by the Israeli airlines for the Company will not exceed 10% of the Company's total flight hours (including flight hours that will be carried out in wet leases by the Israeli airlines, but not including leased aircraft from foreign companies), and they will operate in specified aircraft models in routes from/to Israel to destinations to which the flight range to them from Israel does not exceed 2,400 nautical miles. The Company will continue to plan the employment of its air crews at a volume of 83 monthly flight hours on an annual average, as it has done until now, and, in the event of a significant change in external circumstances that will create the necessity to change this policy, the CEO will discuss the matter with the Chairman of the Division for Professional Unions at the Histadrut, before deciding on the matter.
9.4.16 Executives and Senior Management The members of the Company’s Board of Directors are not Company employees. The Chairman of the Board of Directors On January 21 2009 the Company's Board of Directors decided to appoint Mr. Amikam Cohen as Chairman of the Company's Board of Directors (hereinafter: the “Chairman”), starting February 1 2009. On April 30 2009 the Audit Committee and the Company's Board of Directors approved a service agreement with the Chairman (hereinafter the "Service Agreement"). On June 24 2009 the General Meeting of the Company's shareholders ratified the Service Agreement. According to the Service Agreement, the Chairman shall provide the Company with active Chairman services as expected in publicly-owned companies in the field of activity of the Company and of its subsidiaries, as they exists on the date the service agreement was made and as may be from time to time (hereinafter –the "Services"). In return for the services, the Chairman shall be entitled to the following: (a) a monthly salary of 90,000 NIS plus VAT linked to the CPI (hereinafter –the "Remuneration"); (b) 4,650,000 non-tradable options exercisable as 4,650,000 regular 1.00 NIS NV Company shares; (c)
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benefits pertaining to the receipt of flight tickets; and (d) reasonable expense reimbursements for travel, hosting and mobile telephone expenses made by the Chairman in the context and for the purpose of providing the services subject to the law and in accordance with Company procedure. The remuneration and the remaining benefits and payments detailed above constitute full remuneration to the Chairman for the provision of services, including for his services as Company director, and with the exception of these he shall be entitled to no additional benefit and/or wage and/or remuneration from the Company of any form, including directors' salary (participation remuneration and yearly remuneration) for his as a Company director. In the event that the Chairman ceases serving as Chairman or the Board and continues serving as a director at the Company, he shall be entitled only to a Director's salary (participation remuneration and yearly remuneration) in accordance with the remuneration paid Company directors at the time as well as flight ticket entitlements awarded Company directors. The aforementioned options, exercisable as 4,650,000 ordinary 1 NIS NV Company shares constituted 0.95% of the Company's issued and paid-up capital as of the signing of the Agreement. The options were granted as part of the Company's 2006 option plan and were issued to the Trustee for the Chairman in accordance with Section 102 of the Income Tax Ordinances (New Version), 1961, in the capital gains track and may be exercised as Company
shares, subject to adjustments and as detailed below: The exercise price of each option shall be NIS 0.885, the closing price of a Company share on February 1 2009, which is when the Chairman of the Board began his tenure. The right to exercise the options shall vest in three equal yearly portions (one third each year) throughout the Chairman's first three years. In the event of the discontinuation of the Chairman's service past the end of the first year from the issue date, the options shall vest on a quarterly basis. The number of options and/or the vesting price, as the case may be, shall be subject to adjustments as detailed in the Service Agreement, including adjustments due to dividends, due to
mergers/acquisitions or acceleration due to changes in control. In accordance with the value assessment provided by an independent outside value assessor, and in accordance with the calculation made by the value assessor in accordance with the Black & Scholes model (as well as reference to Binomial options pricing model for comparison), the value of the options, based on the following parameters, for the date on which the option plan was approved by the Company's General Meeting on June 24 2009 was 1,310,000 NIS (some $332,000 on that date). The parameters used by the assessor to determine the value assessment were, among other things, the value of the Company's stock on June 24 2009 (0.879 NIS), the
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exercise price set at 0.885 NIS, the options' average lifespan, the fact that the options are granted in three portions and the fluctuations of the Company's shares throughout the vesting period. The parties' entry into the Service Agreement was retroactive starting February 1 2009 until the date the Chairman ends his service as Chairman of the Company's Board of Directors for any reason. In spite of the above, the Service Agreement can be revoked by either of the parties for any reason with advance written notice of 90 (ninety) days.
Directors On February 17 2010 the Company's General Meeting approved the extension of the tenure of Mr. Yair Rabinowitz as external director with accounting and financial capabilities for an additional 3 year term, starting March 1 2010. On January 19 2011 the Company’s General Meeting ratified the extension of the tenures of the directors serving on the Company's Board of Directors (who are not external directors) as follows: Amikam Cohen, Tamar Moses Borowitz, Yehuda (Yudi) Levi, Professor Israel (Izzy) Borowitz, Amnon Lipkin-Shahak, Amiaz Saggis, Nadav Palti, Eran Ilan, Pinchas Ginsburg and Shlomo Hannael as well as the appointment of Sophia Kimmerling as member of the Company's Board of Directors, until the conclusion of next annual General Meeting. On March 9 2011 Professor Israel (Izzy) Borowitz announced his resignation from the Board of Directors starting that date. For details see the Company’s immediate report dated March 10 2011 (ref. 2011-01-075966).
The Company CEO On October 21 2009, the Company's Board of Directors decided to appoint Mr. Eliezer Shekedi as the Company's CEO (hereinafter –the "CEO"). On January 6 2010 the Company’s Audit Committee and Board of Directors approved the engagement with the CEO via the employment contract (hereinafter: the “Employment Contract”) which came into effect retroactively starting November 1 2009, the key points of which being the following: The CEO shall be subordinate to the Company’s Board of Directors. The CEO's gross monthly salary shall be 115,000 NIS, linked to the Consumer Price Index on the basis of the known index, with the basis index being the CPI published December 15 2009.
The CEO shall be entitled to a bonus comprised of the following three components:
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(a) "Profit bonus" - a sum equal 2.0% of the Company's yearly pre-tax profit appearing in the Company's consolidated and audited yearly Financial Statements (the "Yearly Statements") this for each calendar year during the CEO's tenure as Company CEO (the "Tenure"), starting
2010, when such a profit was achieved and for any portion of such a calendar year; as well as: (b) "One-time bonus" – a one-time bonus to the amount of two million NIS for the first calendar year over the course of the tenure in which the Company achieved a pre-tax yearly profit, this in accordance with the yearly statements for the year in question (the "Base year") and an additional (and final) one-time sum of one million NIS for an additional calendar year over the course of the tenure, in which the Company achieved a pre-tax yearly profit, this in
accordance with the yearly statements for the year in question; as well as: "A result improvement bonus" – a sum of up to 2.0% of the aggregate improvement to the Company's yearly pre-tax profit, starting from the base year until the end of the tenure, according to the yearly statements. This bonus shall be paid the CEO for the base year and for each subsequent calendar year in which an improvement occurred (if any) in the yearly profit in question compared to the previous peak year in the tenure, with "previous peak year" in this regard being a previous calendar year, starting from the base year, in which the Company's highest pre-tax profit was achieved to date for which the bonus in question is paid. Eligibility for this bonus shall apply only if (a) a pre-tax yearly profit was achieved for the calendar years during the tenure in accordance with the relevant yearly reports; as well as – (b) under the condition that the profit in question is larger than the pre-tax profit achieved un the previous peak year, and – (c) due to the difference (delta) only between the two profit sums in question (with the exception of for the base year in which the bonus in question is calculated for the entire pre-tax yearly profit for that year). In addition, the Company granted the CEO 9,914,382 options exercisable as 9,914,382 ordinary 1.00 NIS NV Company shares, which constituted, as of the signing of the option agreement (approved pursuant to the approval of the Employment Contract) (the “Options Agreement”), 2% of the Company's issued and paid-off stock capital, 1.90% fully diluted. The options were granted on February 7 2010 in accordance with the Company's 2006 option plan and in
accordance with the Options Agreement with the CEO. The options were placed in trust for the CEO in accordance with Section 102 of the Income Tax Ordinance, on a capital gains track, and are exercisable as Company shares, subject to
adjustments and as detailed below: Vesting – The right to exercise the options shall vest in three equal yearly portions (one third each year) throughout the CEO's first three years in service. In the event of the discontinuation
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of the CEO's employment after the end of the first work year the options shall vest on a quarterly basis. In the event of the discontinuation of the CEO's employment within six months after a change of control event (as defined in the Options Agreement), all options allocated to the CEO the vesting date of which has yet to be reached shall vest immediately, and they shall
be exercisable within 12 months from the date on which the CEO stopped working in practice. Exercise Price – The exercise price of each option shall be 0.965 NIS, the closing price of a
Company share on November 1 2009, which is when the CEO began his tenure. Exercise Period – Any portion of options vested may be exercised up to six months from the vesting date of that portion, or at the end of twelve months from the actual end of the CEO's
employment. Adjustments – the amount of options and/or the exercise price, as the case may be, shall be subject to adjustments as detailed in the Options Agreement including adjustments due to
dividends and due to merger/sales agreements. The economic value of the options – in accordance with the value assessment provided the Company by an independent outside value assessor, and in accordance with the calculation made by the value assessor in accordance with the Black & Scholes model (referring to Binomial options pricing model for comparison), the value of the options as of January 6 2010 is 3,847,000 NIS (on the date of the approval of the commitment the value of the options was 3,293,000 NIS). The parameters used by the assessor to determine the value assessment were, among other things, the value of the Company's stock on January 6 2010 (0.879 NIS), the exercise price set at 0.965 NIS, the options' average lifespan, the fact that the options are granted in three portions and the fluctuations of the Company's shares throughout the vesting period. The CEO shall be entitled to social benefits such as executive insurance provisions or pension funds, loss of work ability and education fund, as are commonly granted Company senior executives. In addition, the CEO shall be entitled to 30 paid sick days per year (which may be accumulated to up to 120 days, but not redeemed), 16 convalescence days per year, as well as 25 vacation days per year (which may be accumulated, unlimited in amount and redeemable). In addition, the CEO shall be entitled to reasonable personal and hospitality expenses, spent as part of his duties and in return for appropriate receipts/ invoices. The employment contract was made or an unlimited term and established that each party may discontinue the agreement subject to providing advance notice as follows: (a) during the first year of work – if the Company has discontinued the agreement or if the discontinuation was with both parties’ consent, the advance notice period shall be 3 months from the end of work in
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practice or by December 31 2010, whichever is later, and if the agreement is discontinued by the CEO the period shall be 3 months in length; (b) if advance notice on the agreement's discontinuation is given during the second year of work – if the Company has discontinued the agreement or if the discontinuation was with both parties’ consent, the advance notice period shall be 12 months from the end of work in practice, and if the agreement is discontinued by the CEO the period shall be 6 months in length; (c) if the advance notice regarding the discontinuation of the agreement is given after the completion of the second year of work, the advance notice period shall be 12 months from the end of work in practice, whether it was discontinued by the Company, by the CEO or with their mutual consent. In this regard, the “end of work in practice” means the date set by the Board of Directors (or a Board committee) as the date on which the CEO’s work at the Company ended in practice. Upon the discontinuation of the CEO's employment, for any reason, with the exception of criminal circumstances, the CEO shall be entitled to, in addition to the payments specified above, a retirement bonus to the amount of a single monthly salary multiplied by the amount of years he worked at the company (not including the advance notice period), including for a portion of a work year, this according to the CEO's last pay slip. This agreement includes confidentiality and non-compete clauses, according to generally accepted practice, for a 12 month period from the actual discontinuation of work. The Company shall provide the CEO with a mobile phone, a telephone line and home fax machine and shall bear full maintenance and usage costs as well as payments for calls. The Company shall provide the CEO and his household with a Licensing Group 6 vehicle. The Company shall bear all costs involved in the use and maintenance of the vehicle, according to Company practice and its procedures as updated from time to time. The Company shall pay the tax payments borne by the CEO for the vehicle and telephone at his disposal. The CEO shall be entitled to flight tickets for himself and for his family according to Company practice regarding any person serving as CEO, this according to existing Company procedures, updated from time to time.
Excelling Employees Fund As part of the negotiations with the CEO regarding the terms of his employment at the Company and at the CEO's request, the Board of Directors approved the establishment of a CEO fund for the remuneration of excelling employees, to the amount of 2 million NIS. This fund shall be established after the Company's financial results show an improvement of over
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50% over 2009. Use of this fund shall be at the discretion of the CEO to provide incentives to
excelling Company employees who are not Management members.
For details regarding the announcement made by the Company’s CEO regarding his decision to provide the “Excellence and People” fund with a sum equivalent to 50% of the yearly bonus owed for 2010 see Regulation 21 in Chapter D of the 2010 periodic report
The Former Company CEO Note that in accordance with the entitlement of the outgoing CEO, Mr. Chaim Romano, to a result-dependent bonus payment for a six month period out of the advance notice period according to his employment agreement, the Company's Board of Directors decided that the bonus shall be calculated on the basis of the months of January through June 2010. In accordance with the Company's financial results, the bonus in question amounts to $647,000, paid near the publication of the Company’s Q2 Financial Statements.
Audit Report – Securities Authority On March 10 2011, the Securities Authority provided the Company with an audit report regarding the terms of the employment of senior Company executives, including the Company's outgoing CEO, Mr. Chaim Romano. For details on this issue, including regarding decisions made following the audit report in question, see immediate reports published by the Company on March 10 2011 (reference numbers: 2011-01-075912 and 2010-01-075966) and on March 14 2011 (reference number: 2011-01-080034). For details regarding a request to approve as derivative a claim filed against the Company by a shareholder regarding the employment contract of the outgoing CEO, see 9.14.11 below.
Senior Executives In April 2010 Mr. Benjamin Livneh was appointed as the Company VP of Operations, starting May 1 2010, replacing Mr. Lior Yavor who ended his term in office in April 2010. In June 2010 it was decided to cancel the position of the CEO’s Chief of Staff and Mr. Rami Iskov ended his term in office as the CEO’s Chief of Staff starting June 10 2010. In November 2010 Mr. David Meimon (who had served as the Company's VP of Customers since 2009 and as a Company VP since 2005) was appointed VP of Trade and Aviation Relations, starting December 1 2010, replacing Mr. Eli Cohen who ended his term in office starting November 2010.
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In November 2010 Ms. Yehudit Grissero (who had served as Head of Flight Services since 2009) was appointed VP of Services, starting January 1 2010, replacing Mr. David Meimon who was appointed VP of Trade and Aviation Relations. In November 2010 Mr. Ofer Gatt (who had served as the Manager of El Al North America since 2007) was appointed as VP of Global Sales, starting January 1 2011. In January 2011 Mr. Shalom Zahavi (who has served as Head of Cargo at the Company since 2009) was appointed VP of Cargo, starting January 6 2011. In addition to the CEO, other senior personnel are employed under personal employment agreements. The salary of the senior personnel under personal agreement is updated, so that the overall salary is linked to the CPI and updated each year, in the month of January, after deduction of the cost-of-living increments paid. In cases where the personal agreement is silent as to eligibility to augmented severance pay, the Company customarily approves incremental severance pay at the rate of one month per year of work. See also Section 9.4.5 above for a description of the options plan. At a Special Meeting of Company Shareholders held July 14, 2005, a resolution was approved for an addendum to bylaw 158a of the Company's bylaws. The addendum stipulated, inter alia, that the salaries of officers (with the exception of directors not employed by the Company, and excluding the CEO, a controlling shareholder, a relative of a controlling shareholder, and an interested party of a controlling shareholder), where an exceptional transaction is not involved, will be approved by the Human Resources Committee and Board of Directors appointments. The following details the number of employees in the category of Group executives and senior management personnel during 2010 and 2009: Number of Employees45
December 31 2010 December 31 2009
CEO 1 1
Senior management 11 10
Expanded management 33 34 and additional senior
employees46
45 Pursuant to the organizational structure (as opposed to salary levels). 46 Not including CEO and senior management.
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9.5 Raw Materials and Suppliers 9.5.1 Fuel a. The principal raw material employed by the Company is jet fuel. Jet fuel is one of the Company's main expense components, as it is for every airline. In 2010, jet fuel expenses represented approximately 37% of the Group’s operating expenses (compared to 33% in
2009).
b. The price of jet fuel has a material effect on the Company’s profitability. In the Company’s estimation, at its operating level as of the date of the report, every increase of 1 cent in the price of a gallon of jet fuel over the year increases the Company's fuel expenses by $2.5 million.
c. Starting 2001, the Group has taken actions to hedge part of the forecasted jet fuel consumption. A special committee of the Board of Directors for the management of market risks sets the Company’s policies on the hedging of jet fuel prices, the hedge period and the proportion of the hedge out of total jet fuel consumption for that period. The Company requests proposals for framework arrangements from several financial institutions and fuel companies with which the Company has contacts, carries out commercial negotiations with them and executes the hedge transactions with them. The accounting between the parties is done once each period, and if the average price for the above period in the market is higher than the hedged price, the Company receives a refund in the amount of the price difference multiplied by the quantity for that period; where the average monthly market price is lower than the hedged price, the Company pays the difference multiplied by the quantity for that period. In 2010 the Company paid $50 million for a hedging transaction conducted in the past as a result of the above hedging policy.
d. On March 15 2011 the Company announced that it had conducted sales and purchase transactions of certain financial instruments pursuant to its jet fuel hedging portfolio for the period between September 2011 and March 2012, mainly consisting of replacing some of the financial instruments used to hedge jet fuel in the period in question with other financial instruments, while making an early realization of hedging revenues to the amount of $31 million and purchasing other financial instruments worth $6 million in such a manner that the total result of the actions in question derived a cash bonus of $25 million that entered the Company's accounts. Hedging revenues to the amount of $31 million shall be recognized in the Company’s Statements of Operations based on the original repayment dates of the transaction for the period in question of which $22 million shall be recognized in the second
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half of 2011 and the balance to the amount of $9 million shall be recognized in the first quarter of 2012. The sales transactions have no impact past that described above on the Company’s jet fuel hedging for other periods.
For details regarding the Company’s hedging policy see Section b.1.(2) of the Board of Directors’ Report and Note 31c to the Financial Statements.
e. In 2010, the average market price of jet fuel rose by 34% over 2009 before hedging transactions. The effect of this price increase on the Company's operating results is substantial.
Following the increase in jet fuel prices the Company decided to update its fuel surcharge starting April 1 2011.
f. The Group purchases fuel in Israel and abroad. In 2010, the Company purchased fuel from two Israeli suppliers who were chosen in a tender process, with approximately 80% of its fuel purchases in Israel from one supplier (Paz). Starting 2011, the Company purchases fuel from three suppliers.
g. The Group purchases jet fuel abroad from a number of suppliers, including fuel companies that supply jet fuel to a large number of airports. The overseas contracts are usually for a one-year period. Most of the contracts are signed after commercial negotiations with several parties which the Company approaches in order to obtain bids each year, except for those stations where there is only a single supplier or stations at which the Company has found it to be feasible to contract with the supplier for a period exceeding one year. As of this report, the Group has agreements for the purchase of jet fuel overseas through May 31, 2011.
h. From time to time, the Company reviews the feasibility of importing jet fuel independently as opposed to purchasing from local suppliers, and carries out these activities based upon market conditions.
i. The Company purchased approximately 40% of its total fuel purchases (in Israel and abroad) during 2010 from one supplier (Paz). The Company has seven additional fuel suppliers from which it purchased more than 5% of its total fuel purchases in that year. The Company does not consider itself dependent on any one fuel supplier.
j. In 2003 the Company initiated a policy of maintaining an inventory of jet fuel, which was purchased from local suppliers. As of December 31, 2010, the Company held fuel purchased from suppliers in Israel and abroad to the amount of $10.2 million.
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k. In addition to fuel suppliers, the Group receives refueling services in Israel from other suppliers.
9.5.2 Aircraft a. All of the aircraft operated by the Company were manufactured by the Boeing Corporation. The Company has a material dependence on Boeing both with respect to spare parts as well as with respect to engineering support. At the same time the Company estimates that the
likelihood of termination of engineering support is low.
b. For details regarding agreements for the purchase and sale of aircraft and engines see Note
16e to the Financial Statements.
9.6 Working Capital 9.6.1 Inventories
The Company has an inventory of raw materials that include jet fuel for consumption, duty-free products to be sold in flight, and expendable inventory (chemicals, food, etc.) for the use of passengers during flight. The following is a calculation of average inventory days:
2010 2009
Fuel inventory 5 6
Inventory of food and supplies for 41 43
passengers
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Duty Free Inventory Purchasing Policy
The Company purchases 80% of its duty-free products from DFASS and the rest of its duty-free products are Israeli products purchased directly from local suppliers (20%). Products are selected by a committee consisting of Company employees including representatives of the purchasing, marketing and customer units, in accordance with market survey considerations (consumer preferences, foreign companies, BGN duty free), potential product profitability, package size and more.
Regarding DFASS products, after products are selected by the Company, orders are made for a period of 2-3 months. Supply of products to the duty free warehouse is carried out in a single occasion.
Alcoholic beverages and cigarettes are provided directly to the duty free warehouse, on a quarterly basis, with the remaining products provided to El Al stations, and the Company shipping them on the basis of available space in Israel.
The Company is entitled to return any product (not food, tobacco or logo products) so long as the product is in its original packaging. The Company is responsible for sending the products including shipping and insurance costs to their point of supply (cigarettes and alcoholic beverages from the duty free warehouse, other products to the Company's overseas station). Product returns also include products classified as hazardous materials (such as perfumes).
Regarding the purchase of Israeli products, after receiving the approval of the committee mentioned above for the product offered for sale on the plane, an agreement is signed with the product's supplier along with an initial offer (the minimum amount is 250 units). Supply of products to the Company is under export conditions and the warehouse in which the products are stored is a bonded warehouse.
The Company reserves the right to discontinue sales of a certain product at its sole discretion. In such a case, the Company is entitled to return the entire remaining inventory (in whole or in part, as it chooses), but shall make a reasonable commercial effort to reduce the amount of products returned to the supplier. The supplier shall be responsible for any taxes that need to be pay customs agents to free the returned products from the bonded warehouse.
The Company provides the supplier with "framework orders" for a 3-4 month period and the duty free warehouse withdraws the required amount from time to time. No amount may be withdrawn past the amounts in the framework orders.
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Storing Products in the SLN Warehouse
All purchased products are stored in the duty free warehouse (a separate unit within the SLN warehouse, with restricted access). Products requiring special storage conditions (such as chocolate), are stored in refrigerated conditions. The value of inventory in the warehouse at any given moment averages one million dollars. Orders are made on a periodic basis, including multi-seasonal products (sold throughout the year) in order to maintain a low inventory level. Inventory is kept by the Purchasing buyer, along with a representative of the Duty Free Unit and a representative of the duty free warehouse, to keep up to date on planned sales, expiring products in inventory and so on.
For details regarding the extant of the inventory see Note 11 to the Financial Statements.
9.6.2 Reservation Cancellation Policies
In general, Company policy is that a customer is permitted to cancel a reservation, without payment, until the date that the ticket is issued to the customer (“ticketing”). The customer may cancel certain tickets even after ticketing, at times without the payment of cancellation fees and at times with payment of a cancellation fee. Tickets also exist that the customer may not cancel at all after ticketing. Generally, the higher the ticket price, the greater the willingness to allow cancellation of the ticket without cancellation fee or with a low cancellation fee.
The above is subject to the fact that legal requirements do not demand otherwise. In this regard note that as regards long-distance sales or transactions carried out as a result of material misrepresentation or taking advantage of distress as well as regarding specific transactions for the sale of flight tickets in domestic flights the Consumer Protection Law, 1981 and the Consumer Protection Regulations (Canceling Transactions), 2010 provide special instructions regarding the possibility of cancelled transactions – see Section 9.11.2.(j) below on this regard.
9.6.3 Policies for Providing Assurance for Services
The Group’s responsibility for damages (bodily damages and property damages) caused in the course of international air transport are stipulated in international conventions adopted in the Air Transport Law, 1980 and the decrees which have been issued under its auspices. The Group also operates in accordance with IATA directives on various matters connected to responsibility for passengers and their luggage. The Group’s responsibility for denial of boarding of passengers due to overbooking of flights is established by the Aviation Services Licensing Regulations, 1985. In addition, with regard to everything that is related to bumping passengers from flights, flight delays and flight cancellations to and from countries belonging to the European Union,
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Regulation 261/04 of the European Union applies to the Company (see Section 9.11.2.(e) below). A bill is currently before the Knesset Finance Committee on Compensation and Assistance to Passengers due to Delaying or Bumping Passengers from Flights, 2010, which is designed to adopt Regulation 261/04 of the European Union and to apply it to all flights (scheduled and chartered) from all destinations, including flights departing from Israel. For details regarding the bill and legislative amendments in the field of consumer protection see 9.11.2.(e) and (j) below.
9.6.4 Credit Policies a. Credit to customers: Travel or cargo agents approved by IATA enjoy special payment arrangements in accordance with IATA regulations (a non-IATA agent is obliged to provide guarantees or pay in cash). The Group grants credit to agents in Israel for periods varying between 15 to 45 days. In general, direct sales of air transport to customers are made in cash,
other than credit sales to Government ministries and certain commercial customers.
b. Suppliers’ credit: The Group receives credit from its suppliers in Israel for periods between
30 to 90 days, in accordance with the type of supplier and the arrangement with him.
c. The following are the average credit volume and credit periods for Group customers and
suppliers in 2009 and 2010:
2010 2009 Average Credit in Average Days Average Credit in Average Days Millions of Dollars of Credit Millions of Dollars of Credit Trade 153 27 128 27 receivables Trade 148 45 139 48 payables
d. Note that the gap between the customer credit policy and its supplier credit policy derives, inter alia, from the fact that the supplier credit policy is set by the Company, taking into account market conditions, liquidity and generally accepted policy. On the other hand, the customer credit policy is largely set according to generally accepted practices in the aviation industry and in accordance with ordinances and procedures accepted by the IATA and travel
and cargo agents.
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9.6.5 Working Capital Deficit As of December 31, 2010, the Group had a working capital deficit of 315 million, compared to $385 million at the end of the previous year. The Company’s current ratio as of the end of 2010 is 57% compared to 44% at the end of the previous year. See Section a.1 of the Board of Directors' Report for details of the factors leading to the decrease in the working capital deficit. The working capital deficit consists of three material elements included under the Company’s current liabilities items and characterized by current business cycles: unearned revenues from the sale of flight tickets including port taxes, unearned revenues from frequent flyer clubs, as well as employee vacation obligations. Therefore, a material part of the capital deficit is not
cash-flow based and allows the Company to repay its short-term liabilities.
9.7 Investments
See Note 15 to the Financial Statements for details of all of the investees of the Company.
9.7.1 A Concise Description of the Businesses of Principal Subsidiaries: a. Sun D’Or International Airlines Ltd. (“Sun D’Or”) The Group's charter operations described above and below, are carried out through Sun D’Or (a fully owned El Al subsidiary). Sun D'Or leases the entire capacity of aircraft to third parties, or the capacity of part of an aircraft to a number of partners at prices agreed upon in advance. In addition, Sun D'Or also deals in the sale of tour packages by way of tourism wholesalers as well as online sales. Sun D’Or has a commercial operating license that provides, inter alia, that the flights will be carried out on aircraft leased from EL Al to Sun D’Or and that BGN will be Sun D’Or’s home base. Furthermore, Sun D'Or has a commercial operating license to transport passengers and cargo on charter flights to and from Israel, produced by the CAA on a yearly basis. Following Government Resolution 3024 dated January 2008 (see details in 7.1.2 above), starting 2008 Israeli airlines including Sun D'Or were also appointed Designated Carriers for scheduled flights to a number of destinations. In March 2010 Sun D'Or received authorization from the Ministry of Transportation to operate scheduled flights on the Tel Aviv-Minsk route and it began operating these flights in June 2010. As noted, the Company ceased operating flights on this route in November 2008 and starting December 2008 flight on this route took place using a code sharing agreement with Belavia Airlines. The Company cancelled this agreement in October 2009,
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in light of the legislative change requiring the consent of the Restraint of Trade Commissioner for code sharing agreements (see 9.11.2 for further details). In addition, in 2010 Sun D’Or was appointed Designated Carrier to Riga (Latvia), Lisbon (Portugal) and Almaty (Kazakhstan). For a full list of the destinations to which Arkia, Israir and Sun D’Or were appointed Designated Carriers, see 9.11.7.2 below.
In late 2009 the Civil Aviation Authority reviewed Sun D'Or's compliance with Aviation Law requirements and resulting regulations. The CAA made several requirements, including a requirement according to which a number of employees shall serve exclusively as full- time Sun D'Or employees and shall not be loaned from the Company. Sun D'Or complied with the CAA requests and Sun D’Or’s operational operating license was updated accordingly on February 1 2010. On March 20 2011 the CAA informed Sun D’Or that it would be revoking Sun D’Or’s operational license starting April 1 2011. This announcement by the CAA followed talks between the CAA and Sun D’Or and the CAA’s requirements regarding Sun D’Or’s licensing and its operational performance and following a proceeding held before the European Commission on March 16 2011, to which CAA and Sun D’OR representatives were invited in order to provide explanations regarding the structure of Sun D’Or and its operations, in order for the European Commission to decide whether to place operational restrictions on Sun D’Or’s flights to Europe. The Company and the CAA have established a team to examine a possible solution for Sun D’Or’s flights. The Company is studying the announcement and its total possible implications, but at this stage the Company has no financial estimate pertaining to the announcement. Sun D'Or's revenues amounted to $88,638,000 in 2010 compared to $75,785,000 in 2009 and $85,311,000 in 2008. As of December 31 2010, Sun D'Or employed 33 people. For further details see Note 15.a.(4) to the Financial Statement. b. Tamam Aircraft Food Industries (BGN) Ltd. ("Tamam") Tamam (a fully owned El Al subsidiary) is primarily engaged in the production and supply of prepared kosher airline meals. Tamam is located in Israel and its offices are located outside Ben Gurion Airport. El Al is the principal customer of Tamam. In 2010, approximately 85% of its sales were to El Al, with the remainder to other airlines and to other customers. Tamam’s revenues in 2010 totaled $25,193,000 compared to $22,014,000 in 2009 and $21,589,000 in 2008. As of December 31 2010, Tamam employed 318 workers (not including outsourced workers; including two employees loaned by El Al and not
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including 9 employees taking absence without pay). Note that in March 2011 Mr. Amit Schwartzman was appointed CEO of Tamam. For further information on Tamam see Note 15.a.(1) to the Financial Statements.
c. Katit Ltd. ("Katit") Katit (a fully owned El Al subsidiary), deals mainly in the manufacture and supply of means to Company employees. Katit is based in Israel and its offices are at Ben Gurion Airport. In 2010 86% of its sales were to El Al. Katit's revenues in 2010 were $3,456,000 compared to $3,248,000 in 2009 and $3,163,000 in 2008. As of December 31 2010, Katit employed 95 people. For further details see Note 15.a.(5) to the Financial Statements. d. Bornstein Caterers Inc. (USA) (“Bornstein”) Bornstein (a fully-owned El Al subsidiary), incorporated in the United States and operating out of New York’s JFK airport, deals mostly in the production and delivery of prepared meals for airlines and other institutions. El Al is the Bornstein's primary customer (approximately 56% of its sales in 2010). Bornstein’s revenues in 2010 totaled $10,713,000 compared to $9,715,000 in 2009 and $10,380,000 in 2008. As of December 31 2010, Bornstein employed 87 workers. See Note 15.a.(2) to the Financial Statements for further details about Bornstein. e. Superstar Holidays Ltd. (Britain) - (“Superstar”) Superstar (a fully-owned El Al subsidiary), is a tourism wholesaler marketing tour packages to travel agents and individual travelers, and selling airline tickets on El Al routes at reduced prices. In recent years, Superstar has become one of the largest tour operators in Great Britain for tourism to Israel. The Company has operations in several other countries. Superstar’s revenues in 2010 were $15,774,000.47 Compared to $16,499,000 in 2009 and $23,638,000 in 2008. As of December 31 2010, Superstar employed 14 workers (10 full- time and 4 part-time). See Note 15.a.(3) to the Financial Statements for further details.
9.7.2 The following is a concise description of the businesses of the principal investees that are not subsidiaries:
f. Cargo Consolidation: Air Consolidators Israel Ltd. ("ACI") ACI (a company in which the Company holds all of its Type B shares, granting the Company the right to appoint one half of the number of directors as well as participate and vote in general meetings) is primarily engaged in the consolidation of air cargo at BGN in order to reduce the price of airborne shipments. Air transport is carried out by the Company,
47 The amount in thousands of dollars has been translated from pounds sterling according to the December 31 2010 rate of exchange.
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at special prices, as well as by foreign companies. The shares do not provide El Al with the right to receive dividends or any other benefit granted by ACI, other than earnings and
dividends distributed from capital gains. In 2010 the Company paid commissions to ACI to the amount of $947,000. The Group is evaluating the possibility of changing its holdings in ACI. For further details see Note 15.b.(2) to the Financial Statements. ACI's revenues in 2010 were $35,226,000 compared to $25,903,000 in 200948. As of December 31, 2009, ACI employed 21 workers. g. Flight Marketing: Air Tour (Israel) Ltd. ("Air Tour" or "Tour Air") Air Tour (a company 50%-owned by El Al) markets El Al flights and special promotions to all El Al destinations. The Air Tour shares held by the Group grant it the right to participate and vote in shareholders’ meetings and to appoint half of its directors, but do not grant the Group the right to receive dividends or earnings, other than earnings derived from share capital investments of Air Tour. For further details see Note 15.b.(1) to the Financial Statements The Company pays Air Tour handling fees for certain actions carried out by Air Tour for the Company and in addition participates in one half of its operating expenses. It is Air Tour's policy to transfer the lion’s share of the incentives it receives to travel agents, based on their sales revenues at Air Tour, and to distribute the earnings as dividends to its ordinary shareholders (the travel agents) through dividends. Air Tour’s revenues in 2010 were $3,697,000. As of December 31 2010, Air Tour employed 60 workers.
h. Touring and Hotels: Kavei Chufsha Ltd. ("Kavei Chufsha") Kavei Chufsha (a company approximately 20%-owned by El Al49) deals in the marketing and sale of tourism services, including as a wholesaler and as an organizer of charter flights to and from Israel. The Company’s investment in Kavei Chufsha was made in order to enlarge its marketing channels in the charter flights sector and to expand the Group's hold on the marketing of tourism traffic. Kavei Chufsha performs its marketing via travel agents and by the distribution of seats and touring packages to the end consumer.
i. Maman – with Cargo Terminals and Handling Ltd. ("Maman") Maman is a public company the shares of which are traded on the Tel Aviv Stock Exchange. Maman’s chief activity is the management and operation of the cargo terminal authorized to
48 The sums in thousands of dollars have been translated from NIS at the rate of exchange as of December 31 2010 and December 31 2009, respectively. 49 To the best of the Company's knowledge, the remainder of the shares is held by A. Arnon Aviation and Tourism Ltd. (44%), Cohen Kana Investments Ltd. (35.2%) and Arnon Englander (0.8%).
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handle all import and export cargo at Ben Gurion International Airport, as authorized by the
Airports Authority. In addition, Maman is also active in the field of logistical services, real estate property rental and provides aviation services. Maman’s activity takes place in Israel, the Czech Republic and India. Maman’s revenues in 2010 were 436,677,000 NIS. As of December 31, 2010, Maman employed 492 workers.
9.8 Financing 9.8.1 Loans Not for Exclusive Use The Group does not have any loans (whether from banking or non-banking sources) that are not for exclusive use, excluding a credit facility, as mentioned in Section 9.8.3 below. For details regarding the Company's long-term bank loans see Note 22 to the Financial Statements.
9.8.2 Credit Limitations on the Corporation
a. Observance of Collateral Ratio In accordance with the stipulations featured in each agreement, the Company has committed to some of its long-term credit issuers to maintain a proper collateral ratio between unpaid credit and collateral pledged to the bank. In general, the agreements for credit taken by the Company stipulate that the market value of the aircraft pledged should exceed the bank debt balance by 25% and that this should be verified once a year, on the basis of certain, agreed upon, international professional publications. Whenever the value of the collateral falls below that specified in the agreement, the Company is obligated to provide additional collateral to the lender, so that the ratio, as stipulated in the agreement, is maintained. As of the date of the approval and publication of the report, the Company complies with the restrictions and the financial covenants that were prescribed with the banks. For further details see Note 22g to the December 31 2010 Financial Statements.
b. Single Borrower and Group of Borrowers Limitation The directives of the Supervisor of Banks in Israel include restrictions according to which the debt of a “single borrower” and of a ”group of borrowers” to a bank in Israel shall not exceed a given percentage of that bank’s shareholders’ equity. From time to time, these directives may affect the ability of some of the banks in Israel to grant additional credit to the Company. Due to the change in the holdings in the Company, whereby Knafaim is the controlling shareholder and holds more than 25% of the Company’s issued share capital, the Group is considered a part of the Knafaim group with respect to the borrower-group restriction placed on the granting of bank credit. In addition, in light of the weight of the
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Company’s long-term liabilities to banks in Israel, the Company may encounter difficulties raising additional credit in significant amounts from Israeli banks.
c. Limitations on Transferring Control The Company has made commitments to banks, according to which, should there be a transfer or change of control of the Company in any manner without the consent of the lenders, the lenders are permitted to demand the immediate payment of the loan balances.
d. Demand for Immediate Repayment by the Bank The loan agreements made by the Company include the bank's right to demand immediate repayment of the balance of the loans owed to that bank, as a result of a violation event such as: (a) if, in the bank's opinion, based on reasonable criteria, a change had occurred that adversely affects the Company’s financial position or its operations or its business or its financial ratios, in a manner endangering or potentially endangering the ability to repay the bank loans; (b) insolvency; (c) failure to make timely payments; (d) a situation in which the aircraft for which the loan was granted is uninsured; (e) a cessation of the Company's business and failure to renew them within 45 days from that cessation; and (f) a merger or transfer of control without the advance written consent of the bank. For details see Note 22f to the Financial Statements. For details on the matter of financial limitations and covenants involving the Company's long term loans, see Note 22g to the Financial Statements. As of December 31 2010 and immediately prior to the approval of this report, the Company has upheld these financial covenants and obligations.
9.8.3 Credit Facilities As of December 31 2010 the Company's credit frameworks amounted to $35 million, similar to the credit frameworks at the Company's disposal on December 31 2009. Immediately prior to the approval of this report the Company's credit frameworks amounted to $35 million. Use of these facilities is intended for any purpose.
9.8.4 Guarantees for Collaterals The Company has unguaranteed frameworks to the amount of $29 million from hedging
institutions ($29 million on December 31 2009 as well). As of December 3, 2010 the Company was not required to provide any collateral for its hedging transactions.
9.8.5 Loans for Exclusive Use The Company has taken loans for the purchase of aircraft, the principal terms of which are listed in Note 16 to the Financial Statements. The balance of the bank loans as of December 31 2010
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amounted to $718.4 million. Interest on loans in 2010 moved between 0.3% and 4.01%, and the effective interest on the loans in 2010 moved between 4.2% and 5.7%. As of its price today and based on the future curve as published daily by international commodities institutions, and according to the Company's estimates, no added funds will be needed to be raised to finance the Company's regular operations. The Company's estimates regarding the need to raise additional funds to conduct the Company’s business constitutes forward-looking information, as defined in the Securities Law, which is based upon the price of jet fuel on the date of the report and on the Company’s assessments based mainly on past experience and its experience to date. Therefore, the need to procure additional sources of finance for the Company’s operations may be materially different from the results assessed or implied from this data, as a result of a large number of factors, including changes in jet fuel prices, liquidity considerations, outfitting, unexpected expenses borne by the Company, unexpected events that may have a negative impact on the Company’s activities and changes in interest rates.
9.9 Taxation 9.9.1 Tax Laws to which the Company is Subject According to the Income Tax Regulations (Rules Concerning the Maintenance of Accounting Records of Airlines with Foreign Investments and of Certain Partnerships and the Determination of their Taxable Income), 1986, the results of the Company and some of its subsidiaries are measured for tax purposes on a dollar basis. Some of the subsidiaries are assessed jointly with the Company. Pursuant to the Income Tax Regulations (Depreciation), 1941, the Company is entitled to depreciate aircraft it owns at an annual rate of 30% of cost and spare engines that it owns at an annual rate of 40%. In accordance with the Value Added Tax Law, 1975, transactions for the sale of flight tickets to and from Israel, or from one destination abroad to another, as well as cargo transport by air to and from Israel, have been defined as transactions for which the VAT
rate is zero.
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9.9.2 Status of the Corporation’s Tax Assessments The Company and its subsidiaries have received final tax assessments (including self
assessments regarded as final) for the period through the tax year:
Tax year
The Company 2006
Main direct subsidiaries 2006
9.9.3 Tax Laws Applicable to Significant Affiliated Companies Incorporated Abroad The overseas subsidiaries are subject to the tax laws applicable in the countries of residence. Most of the countries in which the Company operates representative offices are signatories to treaties for the prevention of double taxation or mutual arrangements between the nations, which exempt the Company from the payment of income taxes on its operations in those countries.
9.9.4 Reasons for Material Differences Between the Effective Tax Rate and the Statutory Tax Rate See Note 28d to the Financial Statements.
9.9.5 Accumulated Losses for Tax Purposes The balance of income tax losses as of the end of the 2010 tax year (based on an estimated tax
return for 2010) amounted to a total of $684 million. The Company recognized deferred tax assets for losses accumulated for tax purposes to the amount of $137 million and for deductable timing differences of $29 million. See Note 28 to the Financial Statements. Tax assets were listed after offsetting taxable timing differences deriving from accelerated aircraft depreciation for tax purposes.
9.9.6 Income Tax – Withholding: The Company received withholding assessments for 1998 to 2005 in the matter of the benefit value of flight tickets granted employees – flight tickets on the basis of available seats free of charge or flight tickets with a 50% discount. On February 10 2011 the Company’s Board of Directors ratified the signing of a settlement with the Income Tax Authorities (Ramla Assessment Clerk). This settlement came as a result of a dispute between the Company and Income Tax in which the Company received assessments followed by orders for 1998 through tax year 2005. The sum
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of the assessments issued was estimated by the Company at a total sum of 186 million NIS ($52 million) including interest and linkage differentials to December 31 2010. The key points of the dispute between the Company and the tax authorities was the value of flight tickets, on the basis of available seats and on the basis of reserved seats, granted employees as discounts, as follows: a. For flight tickets granted on an available seat basis, the Company’s position was that the value of the ticket shall be calculated at a rate of 22.5% of the flight ticket price established as a base price for the issue of employee economy class tickets, according to an arrangement conducted in the past with Income Tax which was revoked in 1997. The assessor determined, in assessments issued for the Company for 1998-2005, the value of the flight ticket at variable rates from the average price of economy class tickets, which are higher than the rate set by the Company above (up to 75% of the price of an average ticket), this based on the average load factor for the month in which the flight took place. b. For flight tickets on the basis of a reserved seat the Company allows its employees to purchase in return for a payment of 50% of the cost of a flight ticket set by the Company at an average economy class price, the Company paid fixed tax levels, but in assessments issued for the Company for 2001 to 2005, Income Tax determined that the value of the flight ticket is 214% of the price of an average economy class ticket. c. In addition, the assessments issued for 1998 through 2002 included tax debits for employees stationed abroad for periods of over 4 years as well as for a tax offset paid by Company employees in the U.S. The Company has appealed these assessments before the District Court based, among other things, on economic opinions materially different from those of the Income Tax assessments. The parties held talks to resolve the disputes in question and on February 10 2011 the Company’s Board of Directors ratified a settlement between the Company and the Ramla Assessment Clerk, the key points of which are as follows: a. The Company shall pay Income Tax up to and including 2010 a final and absolute sum of 65 million NIS ($18 million) including payment for the assessments for which the orders were issued for tax years 1998-2005 and the full deduction debts for employee flight tickets and other surplus expenses for 2006 through 2010. Upon the signing of the agreement and its approval by the court, the legal proceedings between the Company and Income Tax regarding the deduction assessments issued for the Company will be concluded.
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b. An agreement regarding the value of flight tickets for Company employees in the purchase of flight tickets on the basis of an available seat and on the basis of a reserved seat, for 2011 through 2013. The settlement was signed on February 10 2011 and received the force of a verdict on February 16 2010. The payment mentioned above was paid by the Company on March 1 2011. For all of the above Income Tax requests, up to and including 2010, the Company made financial provisions exceeding the sum of the settlement described above, and therefore the Company reduced the sum of the settlement listed in its books and recognized other revenues before adjustments and tax influence pursuant to the Company’s operational profit in its 2010 Financial Statements to the amount of $22.3 million. For details see Note 27e to the Company’s December 31 2010 Financial Statements.
9.10 Environmental Issues 9.10.1 Significant Implications of Rules Pertaining to Environmental Matters Many countries, including Israel, have adopted the conventional international standards regarding aircraft engine noise and have prescribed additional directives for environmental conservation. Restrictions exist in various airports in the world as to the times of takeoff or landing of aircraft. Airline schedules, including those of the Group, are determined in accordance with these restrictions. The Company attributes a great deal of importance to the subject of the environment and invests resources and time to this issue (inter alia through the Company's Safety and Quality Branch, which is responsible for these activities). The Company's representatives take part in professional conferences and make sure to remain at the global professional forefront of the relationship between aviation and the environment. Group representatives are also members of the Interdepartmental Committee for the Improvement of Noise Climate at BGN and the Company has put a great deal of effort into this field. Thus, for instance, the Company has mapped its entire areas of interest and assigned each area to a company executive, with each executive responsible for correcting problems in their area of responsibility. The Environmental Supervisor at the Safety and Quality Department conducts regular and continuous inspections throughout the Company to locate environmental hazards. Each Company management forum, which convenes once per week, receives reports of the results of these inspections (including photographs) and conducts follow-up on the correction of these flaws.
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In addition, the Company is undergoing ISO 14001 environmental certification, which is expected to continue until mid-2011. The Company has launched an internal campaign to increase environmental awareness, with each area of the Company having a person assigned as responsible for the environment, pollution prevention and careful use of resources. The Company is acting to complete its writing of work procedures on the matter of environmental protection, training and increasing awareness among Company employees, implementing work processes and increasing enforcement. In this regard, in 2009 a survey was conducted with the aim achieving initial identification and analysis of environmental, work safety and cleanliness issues at Company facilities, and significant improvement was observed in the Company's treatment of environmental issues compared to previous years, this as a basis for establishing environmental indices and goals. The Company has set preserving the environment as one of its goals, and shall act to develop and implement management systems that recognize and take into consideration environmental implications and risks evident in Company activities, inserting environmental awareness into the business planning and business activity, establishing and constantly testing environmental targets and goals, promoting processes and work procedures involved in the reduction of environmental damage, reducing waste, continuing with recycling efforts (in-flight and on the ground), and increasing awareness among Company employees.
9.10.2 Restrictions on Night Takeoffs at BGN Following a government resolution (PS/15 of July 15, 1997), BGN has halted takeoffs between the hours of 02:00 and 05:30, starting October 30, 1998. In the summer of 2002, the Minister of Transportation decided to expand the prohibition on night takeoffs and to set it between 01:30 until 06:00. Some of the foreign airlines in Israel petitioned the High Court of Justice. The case was closed with a compromise under which the petitioners were permitted to start aircraft engines and to make arrangements that would allow the aircraft to depart at 05:50. In May 2010 the municipality of Holon – the head of the BGN Surrounding Authorities Forum (the “Petitioner”) – filed a petition to the Supreme Court, against, inter alia, the Minister of Transportation, the Civil Aviation Authority and the Airports Authority. The Company was not listed as a respondent in the petition. The petitioner petitioned, among other things, to reverse the decision of the Minister of Transportation from April 4 2010 to allow the Airports Authority to open BGN for takeoffs between 1:40 and 5:50 AM (the “Restricted Hours”) on the basis of the claim that these flights
would disturb the residents of municipalities in the BGN region.
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On June 22 2010 the Court issued an injunction prohibiting the respondents from allowing takeoffs during the restricted hours, in the event of flights “resulting from airline operational needs and not due to the load on the airport” only. Following this injunction, no changes were
made to the Company’s flight schedule or to the takeoff permissions granted it. On November 8 2010 the Court issued a ruling clarifying and amending the injunction in question, in which arrangements were set for the winter season, as follows: when a request is received to allow a takeoff outside the restricted hours that cannot be complied with due to the volume of traffic at BGN - the airline shall be offered a takeoff time outside the restricted hours. If the airline refuses to take off on the hour offered, it shall be offered a takeoff slot during the restricted hours as near as possible to their beginning or end; in exceptional cases, takeoffs can be approved between 02:00 and 05:00, this following a detailed and reasoned decision by the head of the Civil Aviation Authority, with a copy produced to the Court and to the petitioner. Following the ruling in question, the Airports Authority announced that it would no longer permit El Al flights on the nights between Thursday and Friday and before holiday eves. In light of this, on November 10 2010 the Company filed a request to join the petition as a respondent and to clarify or revise the injunctions in such a manner so that they no longer apply to takeoffs taking place during the night between Thursday and Friday and the night before Jewish holidays. On November 16 2010, the Court accepted the Company’s request and ruled that the injunction regarding flights during the restricted hours would not apply to the special permission given the Company for specific takeoffs during the nights between Thursday and Friday and during the nights before holiday eves. On November 23 2010 an additional petition was filed before the High Court of Justice by the City of Holon – Head of the Forum of Authorities Surrounding Ben Gurion Airport against the Minister of Transportation and Road Safety, the Minister of the Environment, the Airports Authority, the Civil Aviation Authority and the Company, for the issue of an injunction regarding the permit received by the Company in 1998 to perform takeoffs between Thursday and Friday or before holiday eves, during certain hours of the night. The Company and the other respondents (state authorities) have filed their response in which they objected to the petitioner’s petition based on various arguments. Furthermore, hearings were held before a forum of judges on December 23 2010 and February 8 2011 and the petitioner filed a response to the respondents’ response. Pursuant to this response the petitioner made an offer according to which it would withdraw the petition subject to the statement that the Company would perform no takeoffs at all between 02:00 and 05:00 during summer months and during the winter would only take off during those
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hours to those destinations to which it intends to return before the beginning of the Sabbath, as close as possible to the hours at the beginning and end of the restriction and with the approval of the Head of the Civil Aviation Authority, who shall provide a copy of his decisions to the petitioner. The court requested that the Company and the other respondents reply to the offer in question. The other respondents replied that the petition should be rejected on the grounds of preliminary arguments and on its own grounds, but noted that the Company was the chief interested party in the offer and therefore its reply was needed. The Company submitted a response to the court in which it objected to the petitioner’s offer, inter alia due to the fact that it would worsen the Company’s status relative to permits it has possessed for many years, to the fact that it is based on incorrect data and due to the fact that the petitioner has not established grounds for the court’s involvement and that the petition should be rejected. The Company estimates that the petition’s acceptance would harm the Company’s flight schedule. Furthermore, the implementation of a decision restricting activity at certain hours, as stated above, of aircraft with certain characteristics in the Company's service, may on the one hand have a negative impact on the Company's operational abilities as regards the operation of various aircraft or various flights, particularly the 747-200, 767-200 and 747-400 fleets in the Company's service and thus impact the Company's ability to operate flights. On the other hand, the option to perform takeoffs of certain aircraft at all times of day may have a positive effect on the operational abilities of these aircraft, taking better advantage of their operation. Over the course of 2010 the Company continued its process of removing older aircraft from the Company's operational fleet, in accordance with the El Al 2010 strategic plan. In July 2008 the Company received a letter of warning prior to the filing of a criminal complaint (according to Section 11.e of the Hazard Prevention Law – 1961) from the Israeli Public Committee for the Prevention of Noise and Air Pollution (hereinafter: "MALRAZ"). In its letter to the Company and its executives, MALRAZ claims that in accordance with the noise monitoring reports from 2003 to 2008, a violation has occurred, it claims, of Section 2 of the Hazard Prevention Law. The Company held talks with MALRAZ with the aim of reaching understandings for cooperation. The Company’s estimates regarding the implementation of a decision restricting the activity of certain aircraft or activity at certain hours constitutes forward-looking information, as defined in the Securities Law, which is based on the proposed resolutions, estimates, experience and knowledge possessed by the Company as of the date of the report. Accordingly, the results in practice may be materially different from the results assessed or
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implied from this data, as the result of a large number of factors, including changes in the final wording of the regulatory directives to be enacted, the results of legal proceedings, legal or operational provisions in the destination airports or foreign airports, equipment purchases, environmental implications and more.
9.10.3 Noise Restrictions in the Operation of Aircraft at Airports The noise levels are defined by the International Civil Aviation Organization (ICAO) in Appendix 16 to the Chicago Convention and are catalogued into four levels from Chapter 1 to
Chapter 4, the latter being the most severe level. The most prevalent restriction in most airports in the world is that comparable to Chapter 3. At central airports, such as London, Amsterdam, Brussels, Toronto, New York, Paris and BGN, more severe restrictions than Chapter 3 have been set. As a result, operational restrictions are placed on 747-200 aircraft at those airports (permissible takeoff weight, climb rate after takeoff). All Group aircraft meet Chapter 3 restrictions, and most even comply with Chapter 4 (for 747-200 aircraft taking off at maximum weight, the Chapter 3 restriction is borderline; they do not comply with Chapter 4 restrictions). In addition, according to the decision of the European Union Parliament and Joint Commission of March 2002, the Union's member nations are required to implement policies intended to restrict the operations of aircraft defined as borderline from the standpoint of noise level. The Group has 4 747-200 type aircraft to which this restriction might apply. This policy is meant to be implemented in the following stages: (a) each EU nation will pass the legislation necessary to permit the decommissioning of such aircraft; (b) the performance of an environmental survey at the airports of EU nations, which includes a cost-benefit analysis regarding the continuation of the operation of borderline aircraft at the airports. The survey is to be performed in consultation with the parties affected by its conclusions; (c) in the event that the results of stage (b) lead to the conclusion that there is justification in restricting the continued operation of borderline aircraft in any of the airports, and the aviation authorities will have the authority to instruct the airlines to freeze the number of flights on which these borderline aircraft will be operated at the subject airport, to an extent not to exceed the number of flights during the 6 months preceding the freeze notice; (d) commencing with a date to be determined by the aviation authorities of each nation, and after giving advance notice of 12 months, the activities of the borderline aircraft will be reduced by up to 20% annually in comparison with the maximum volume of activity decided upon. To the best of the Company’s knowledge, as of the date close to the approval of the report, consultation with the airlines has not yet begun in any European country and, in some countries, the relevant laws have not even been passed. If and when the restrictions are imposed, operation
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of 747-200 type airplanes may gradually become economically unfeasible, even impossible. On the matter of flight restrictions related to noise levels created by planes taking off see Section 9.10.2 above. The information on the imposition of restrictions on the operation of 747-200 aircraft or the passing of a government resolution containing certain limitations constitutes forward-looking information, as defined in the Securities Law, which is supported by the Company's assessments based on data in the Company’s possession regarding the progress of legislative proceedings and their application. Therefore, the effective date of the restrictions on the operation of the aircraft could be materially different from that forecasted, as a result of a variety of factors, including the conduct of authorities in the various European countries and the Company's equipment purchases.
9.10.4 Waste Treatment The Company’s waste is treated at a modern central facility within the confines of BGN, approved by the Ministry of the Environment and operated by the Airports Authority. Furthermore, the Company has been operating a facility at a cost of $600,000 since June 2009. The Company facility, built on the Group’s land, transfers the waste to a central treatment facility built by the Airports Authority. The Group pays usage fees to the Airports Authority for the use of the main facility to the amount of $75,000 per year over 22 years (from 2008). At the same time, the toxic waste created by the Company is transported to the Environmental Services Company at Ramat Hovav.
9.10.5 Fuel Tanks All of El Al's fuel tanks were examined during the second half of 2002 by an outside consultant ,who found that all of the tanks were appropriately sealed. In addition, an examination was performed by an authorized laboratory in December 2003, and all of the tanks were found to be in order. The Sonol fuel company also installed viscometers (devices that prevent the seepage of fuel from tanks into the ground) in some of its fuel tanks during the final quarter of 2004, pursuant to the regulations of the Ministry of the Environment. The Group regularly carries out specific treatment of toxic soil waste, if such exist. Over the course of the fourth quarter of 2010 the Company conducted tests of the wholeness of its underground fuel tanks and tests for contamination of the surrounding ground. The fuel tanks have passed pressure tests and have been found to be in order; results of the ground tests have yet to be received.
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9.10.6 Material Environmental Costs and Investments for the Reported Year and Those Anticipated Subsequently The Company carries out a great number of activities and invests financial expenses in improving environmental elements, including the establishment of a waste removal facility that will collect the Company's wastes in the event of deviation from waste quality (in accordance with its agreement with the Airports Authority), separating oil in the Company's yards and performing local separations between the drainage and sewage systems.
2009 2010 2011 (Projected) Thousands of Dollars Material Costs 75 75 75 Material Some 800 Some 350 Some 250 Investments Total Some 875 Some 425 Some 325
Information concerning the material anticipated environmental costs and investments represents forward-looking information, as defined in the Securities Law. The information is based upon the requirements of the environmental laws presently in effect and on current market prices of the goods and services that the Group must purchase in the framework of the environmental investments. Therefore, the actual costs and investments may vary materially from the forecast as above, as the result of a large number of factors, including legislative changes, requirements of the authorities and changes in the prices of the goods and services that the Group will be required to buy within the framework of the environmental investments.
$2 million was invested in 2010 in the renovation of the Katit kitchen serving the Company employee dining room. The renovation was carried out at the request of the Ministry of Health, Ministry of Labor, Ministry of the Environment and the need to meet safety, sanitation and food safety requirements.
9.10.7 Restrictions on the Level of Engine Emissions Following growing world awareness of global warming, governments have become interested in monitoring and restricting the level of air pollution produced by engines. During coming years, laws are expected to be enacted on the matter in different countries all over the world. On January 1 2012 an EU regulation shall come into effect, establishing conditions for the supervision, reporting and confirmation of gas emissions in incoming and outgoing EU flights, this following the inclusion of aviation under emission policies in existence for other branches,
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as established in the EU decision dated June 26 2008. In addition, an economic remuneration mechanism was established, according to which each Company shall receive an emissions cap in light of past emission data. Exceeding this cap will require the purchase of an additional cap and reduction will allow the sale of the cap. Note that calculation of the caps and the economic pricing has yet to be fully established and are subject to fluctuations and changes. Over the course of 2009, airlines were required to submit supervision programs on the subject of emissions. Such plans were submitted on behalf of the Company and were approved. In accordance with the EU decision, the Netherlands were appointed supervisors of the Company's activities. The reporting obligation, reporting procedures the manner of reporting have been fully established and binding directives on this subject have been published The supervising element has inspected the reporting and set down in writing that the Company has successfully passed the inspection
Starting January 2010, the Company has operated a CO2 emission monitoring and tracking system on all of its flights in order to help reduce air pollution and preserve the environment. This monitoring system is automatic in most of the Company's aircraft and manual in some. The
system has been approved by European authorities and is used to collect CO2 emission data. The Company has recently been attached, along with other airlines operating at Sao Paolo Airport, Brazil, to a Brazilian legal proceeding, on the matter of compelling the airlines
operating at Sao Paolo Airport to carry out environmental actions or pay sums of money for CO2 emissions and the hazards created as a result of aviation activity, as claimed by the public prosecutor. The suit against the Company was dismissed by the first level of the court. The degree of the influence of the implementation of legislation or the results of legal proceedings in this regarding on the Company's activity may constitute forward-looking information, as defined in the Securities Law, based on Company assumptions and forecasts. Therefore, the actual results of the passing of these legislative changes or legal proceedings as noted above or their impact on the Company's activities may differ materially from the results estimated or implied by this information.
9.10.8 Fly Green The Company is active in the Fly Green Forum of IATA, and carries out activities with the objective of positioning the Company at the forefront of environmental air protection, inter alia, by using clean fuels (only purchasing fuel from suppliers that comply with the standard's terms), significantly reducing the use of fuel and reducing the emission of pollutants from the Company's planes, by frequently washing aircraft engines, adopting more efficient operating procedures, etc. The Company convenes a panel headed by the VP of Operations once a month
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to deal with this subject. In an outside audit performed in October 2007 for the Company by IATA with respect to fuel savings and reducing pollution, the Company was certified as "exceptional" in this area.
9.11 Restrictions and Regulation on the Corporation’s Business 9.11.1 Overview Most aspects pertaining to the operations of the Company as an air carrier are subject to a system of regulatory arrangements - Israeli and international - which relate, among other things, to flight rights, setting of tariffs, capacity and flight safety standards, security and noise, and are conditional on a commercial operating certificate and an operation certificate. See 9.11.2 below regarding the regulatory arrangements. As to business and operational licenses – see 9.11.3 to 9.11.5 below. The Company’s activity, in addition to the operating licenses, is contingent on it being an Israeli air carrier (principal ownership and real control held by the state or its citizens), on its appointment as Designated Carrier and on the permits issued by foreign companies to make use of the aviation rights granted it as Designated Carrier. See Sections 9.11.6 to 9.11.8 below for information on aviation agreements and Israel’s civil and international aviation agreements. In addition, additional restrictions exist on the Company's activity by virtue of the Special State Share. See Section 9.11.1 below for further details.
9.11.2 Regulatory Arrangements The following are principal regulatory arrangements, Israeli and international, pertaining to the Company's operation as an air carrier. (For security arrangements see 9.11.12 below, for emergency operations see 9.11.13 below). (a) The Aviation Law, 1927 (hereinafter: the "Aviation Law”)
This law, and resulting regulations, arranges, among other things, the following subjects: the registration and nationality of aircraft, approval of aircraft flightworthiness, approval of crews and aviation worker licensing, safety, aircraft operation and flight rules, inspection institute licensing, self-maintenance and more (see also the King’s Decree on Aviation in the Colonies (Issuing Laws), 1937.
In June 2009 the Minister of Transportation issued a draft of the Aviation Bill, 2009, which was replaced by the Aviation Bill, 2010, which is expected to replace, if passed, the 1927 Aviation Law and the King’s Decree on Aviation in the Colonies (Issue of Laws), 1937. The draft bill includes reference to various issues civil aviation was requested to include in the
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legislation, this pursuant to the inspection the U.S. Federal Aviation Administration (FAA) made of the Civil Aviation Administration in order to meet the international standards dictated by the ICAO. The bill proposes to change existing legislation, inter alia, on the subject of aircraft operation, pilot’s licenses, certification and inspection facilities, accident inspection and hazardous material shipping.
The purpose of the bill is to create a comprehensive legal infrastructure for the arrangement of all fields and aspects of civil aviation in Israel while establishing a basis for the adoption of relevant arrangements in secondary legislation, granting requisite professional authorities to the Civil Aviation Authority Manager and granting effective enforcement tools to the Civil Aviation Authority. The proposed law regulates the activities of all factors active in the field of civil aviation – personal licensing of aviation employees (air crews, air traffic controllers, check-in personnel, trainers and instructors) as well as licensing organizations (aircraft manufacturers, airlines, flight schools and maintenance technical certification institutions, airports and airfields and air traffic control units). The Aviation Bill covers a large number of subjects in the field of aviation, including those dealing with aviation issues and their obligations, aircraft, the aviation supervision sector, gliders, supervision rights, safety incident investigations and establishes directives regarding penalties and financial sanctions due to the violation of the law.
As of this report, the Knesset Economics Committee and the Civil Aviation Authority has concluded its deliberations on the wording of the Aviation Bill, 2010. The Aviation Bill, 2010, along with all the changes approved by the Knesset Economics Committee, shall move on to the second and third Knesset votes. Likewise, the Civil Aviation Authority has presented the public with the proposed amendment to the Aviation Regulations (Aircraft Operation and Rules of Flight), 2010, the proposed amendment to the Aviation Regulations (Aviation Worker Licenses), 2010, as well as the proposed amendment to the Institute Regulations (Maintenance Institutes), 2011. The Company has provided its response to the proposed regulations.
(b) Aviation Services Licensing Law, 1963 (hereafter - the “Licensing Law”)50
This law, which regulates the principles of aviation licensing, was amended in 200651 The principles of the law (following the amendment) are as follows:
50 A commercial operating license and an operational license were granted to El Al in accordance with the law - see 9.11.4-9.11.5
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(1) The law prohibits operation of aircraft in a commercial flight, except under license from the Minister of Transportation Road Safety and in accordance with the terms of the license (Section 2 of the law).
(2) The law grants authority to the Minister of Transportation, after consultation with the Minister of Tourism and after obtaining the opinion of the professional committee,52as follows:
(a) When issuing or renewing the license (Section 3 of the law), to stipulate conditions regarding the operation of aircraft, the proposed services, the training and experience of those engaged in operating and inspecting the aircraft, aviation routes to be operated by the license holder and operational standards by which he should operate, frequency of the services, rates and insurance.
(b) To refuse to grant a license if, among other reasons, it might harm regulation of the aviation market, or its planning or the security of the State or be contrary to its interests or the issue does not comply with an agreement between Israel and a foreign country or if the flight might cause damage to public safety or could lead to unfair competition in the civil aviation industry due to prices set below a fair price (Section 5 of the law).
(c) To make a license conditional or to revoke it if one of the following is discovered: (a) one of the license's conditions or a directive under any law that applies to operation of aircraft has not been fulfilled; (b) the aircraft is not operated safely, efficiently, in a capable manner or with proper consideration of public need; (c) one of the grounds exists according to which the Minister of Transportation is permitted to refuse to grant a license in accordance with this law.
The significance of the amendment to the law is the involvement of the Ministry of Tourism (and, to a certain extent, the Ministry of Finance and the Office of the Prime Minister, as well) in the decisions of the Minister of Transportation in the context of his authorities as per the law. See Sections 7.1.10, 7.8.4 above and 9.18.7 below as regards the effect of the changes in competition have on the Company.
51 The law was amended in the framework of the State Economy Arrangements Law (Law Amendments in Order to Achieve Budget Goals and the Economic Policies for the Fiscal Year 2006). The amendment came into effect on July 1 2006 52 A committee composed of the managing directors of the Ministries of Transport, Tourism, Prime Minister and Finance and the Civil Aviation Authority, the function of which is to render an opinion to the Minister of Transportation on any matter relating to licenses, for which an opinion is necessary.
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Note that the Aviation Bill, 2010 included indirect amendments to the Aviation Services Licensing Law for the purpose of adapting the Licensing Law to the new Aviation Law (c) Licensing regulations
The regulations issued under the auspices of the Licensing Law regulate, inter alia, aircraft operation and flight rules, operation of flight schools for flight instruction, transfer and endorsement of transport documents on scheduled flights, flight time restrictions for aviation services, overbooking, licenses for operating and leasing aircraft and operations of charter flights.
(d) The Air Transport Law, 1980
This law and the orders and the notices issued thereunder adopt a number of international conventions that stipulate various rules relating to international air transport, particularly regarding the air carrier’s liability for damages (bodily damage and property damage), caused during international air transport, and the damages imposed on the air carrier for this liability. This law applies the treaty for the purpose of consolidating certain rules pertaining to international airborne shipping (the Warsaw Treaty), and their revisions. In May 1999 a new treaty was prepared in Montreal establishing rules for international civil airborne transportation (hereinafter: the "Montreal Treaty") the purpose of which is to formulate, update and modernize the existing set of rules, including raising the limits of liability for damage caused a passenger's person or property, adding judicial powers and requiring air carriers to take out insurance. In December 1999 the Airborne Shipping Law (2nd Amendment), 2009 was passed, the purpose of which was to create clarity and uniformity in the areas of responsibilities, compensation and authorities in the area of airborne transport while adopting the updated and uniform Montreal Treaty. On January 19 2011 the Consul General of the State of Israel in Montreal submitted a letter to the Manager of the Legal Department of the International Civil Aviation Organization (ICAO) by which the State of Israel joined the Montreal Treaty. Therefore, the Montréal Treaty came into effect in Israel starting March 20 2011.
(e) Regulation 261/04 of the European Union – Compensation of Passengers Denied Boarding
On February 17, 2005, a European Union regulation came into effect establishing conditions for denied boarding ("overbooking") of passengers from flights, flight delays and flight cancellations. This regulation pertains to scheduled and chartered flights that leave from
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countries belonging to the European Union (including flights to Israel). The regulation stipulates, inter alia, compensation to passengers denied a flight and to passengers whose flight has been cancelled without being provided with advance notice within the times specified in the regulation. Additionally, such passengers are entitled to a substitute flight or to a refund of the payment for the flight ticket, at their choice. The regulation also stipulates the right of passengers booked for a flight that sustained an extended delay in the time of takeoff, to a refund of the payment for the flight ticket. In 2004, a private bill was submitted in Israel that is in essence based upon this regulation, but was rejected by the Ministers' Committee on Legislative Affairs and did not pass on the first reading.
In late 2007, the Bill for Damages and Assistance to Passengers due to Delay or Denial of Boarding a Flight, 2007 passed in a preliminary reading in the Knesset. The wording of the bill has been amended several times over the years and currently the Bill for Damages and Assistance to Passengers due to Delay or Denial of Boarding in a Flight, 2010 has been brought before the Knesset Finance Committee. The bill seeks to adopt Regulation 261/04 of the European Union and to apply it to all flights (scheduled and charter), from all destinations, including flights departing Israel. The bill and the regulation were discussed over the course of several meetings of the Knesset Economics Committee and several sections of it were ratified. Passage of the bill could increase the scope of the financial damages paid to passengers by airlines, among them the Group.
The Company's assessment of the scope of the damages if this legislation takes effect could constitute forward-looking information as defined in the Securities Law, which is based on assumptions and forecasts made by the Company. The actual outcome of the change in legislation, as stated above, or the extent of the effect of the change in legislation, if passed, on the Company's operations, may be materially different from the outcome estimated or which might be deduced from this information.
(f) Equal Rights for Persons with Disabilities
In the third chapter of the Equal Rights Regulations for Persons with Disabilities (Accessibility Arrangements to Public Transport Services), 2003, provisions were prescribed regarding the obligation to integrate assistance for persons with disabilities in aviation transport, which imposes various obligations on air carriers as a condition for operating aircraft.
In July 2007, Regulation 1107/2006 of the European Union came into effect, imposing various obligations on the air carrier and the travel agent in all that relates to booking
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reservations and flight check-in, in order to provide special protection for people with disabilities. The Regulation's provisions apply to every flight to and from the European Union states. In July 2008, the regulation dealing with the obligation to provide disabled passengers various means of assistance at airports (for whom the airlines will bear the cost) and which requires airlines to provide their employees with instruction on the subject came into effect. In December 2010 a discussion was held at the Ministry of Transportation regarding a proposed revision to the Equal Rights for Persons with Disabilities Regulations (Arranging Access to Public Transportation Services), 2003, as proposed by the Commission for Equal Rights for Persons with Disabilities. The proposed revision is based on the U.S. Non Discrimination on the Basis of Disability in Air Travel Regulation. In February 2011 the Company provided its response to the proposed revision.
(g) The Airport Authority Law – 1977
This law, the regulations and rules issued under its auspices, regulate, inter alia, the following matters: aviation fees, transport by import couriers, entry into restricted territories, licensing fees and the unloading and loading of aircraft.
The amendment to the Airports Authority Regulations (Fees), 1991 came into effect on January 1 2009, the key point of which being the increase of exit tariffs from $13 U.S. to $21.70 U.S. as well as integrating a linking mechanism for payment of the fees and raising the remainder of fees and services by a rate of 10% across a two-year period (5% from January 1 2009 and an additional 5% from January 1 2010). In June 2010 the Airports Authority announced that it would be closing Runway 26 for renovations for a period estimated at 20 months. Closing the runway in question requires that the Company carry out adjustments to its regular operations, which cause it to bear additional expenses and/or financial losses, including due to added fuel required to operate its flights due to: changes in arriving flight planning definitions; a 15 minute increase in loitering time during busy periods at the airport; extension of the flight route due to changes in takeoff directions, restrictions to takeoff weight due to a shorter runway during the renovation period and a reduction of the possible amount of cargo carried by aircraft in flights to distant destinations, performing takeoffs on a shorter, eastward-facing runway leading to increased engine wear and increases repair costs; furthermore, unavoidable use of greater engine force during takeoffs from a shorter runway may lead to a failure to comply with permitted BGN noise thresholds set by aviation authorities, and may lead to fines for
the Company.
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(h) The Civil Aviation Authority Law – 2005
This law designates the functions of the Civil Aviation Authority, which replaced the Civil Aviation Administration. Among the functions of the Authority are: to determine and assure the existence of internal and international flight regulations according to aviation laws; to grant civil aviation licenses, permits and approvals, according to aviation laws; to supervise the civil aviation sector, including maintaining a proper level of flight safety for Israeli aircraft and for aircraft that are present in Israeli air space.
Lowering of the State of Israel's Safety Rating to Category 2
On December 19 2008 the U.S. Federal Aviation Agency (the FAA) announced that it would be lowering the flight safety rating of the State of Israel to Category 2. This announcement refers to the level of supervision of civil aviation safety in the State of Israel by Israeli aviation authorities including the Civil Aviation Authority at the Ministry of Transportation. Despite the fact that the FAA announcement was not directed at Israeli airlines and that the review or the safety rating do not derive from the performance or the safety of Israeli airlines, the implication of the announcement is the casting of active limitation on airlines flying from Israel to the U.S., including the Company, pertaining, inter alia, to restrictions on increased activity, testing Israeli airlines in the U.S. as well as restrictions on code sharing agreements with U.S. airlines (for details regarding the impact on the code sharing agreement with American Airlines see Section 7.2 above).
The effects of the rating decrease may harm the Company, including by freezing bilateral agreements and the inability to alter existing agreements; freezing commercial agreements without the possibility of submitting requests for added frequencies, adding flight times, changing destinations or receiving new flight destinations; freezing airlines' operational operator's licenses and the inability to add or integrate new aircraft on these routes; damaging code sharing agreements; careful examination of planes arriving from Israel to the U.S, which may lead to significant delays in planned flight times. Note that in March 2009 the Company addressed a letter to the Minister of Transportation and Road Safety in which it noted that the State was responsible for the decreased flight safety rating and the damages caused the Company as a result.
The State of Israel’s safety rating remained unchanged in 2010 and as of the date of the and it has yet to be raised back to Category 1 by the FAA and the Company has no knowledge regarding the date the restoration of Category 1 will occur.
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The Company's assessment with regard to the FAA announcement regarding the safety rating of the State of Israel constitutes forward-looking information, as defined in the Securities Law. Therefore, the actual outcome of this announcement or restrictions pertaining to safety or the extent of their impact, whatever they may be, on the Company's activity may be significantly different from the outcome expected or implied by this information.
(i) The Business Restrictions Law, 1988
Amendment no. 10 to the Restriction of Business Law, which cancelled the statutory exemption currently granted to arrangements between air carriers regarding international shipping, came into effect January 1 2009. In place of the statutory exemption, a class exemption was installed by the Restraint of Trade Commissioner (hereinafter: the "Class Exemption" and "the Commissioner", respectively), which exempts various types of arrangements between air carriers, with the goal of preventing sweeping and unwanted applications of the binding arrangement chapter on the thousands of arrangements which serve as the basis of aviation activity to and from Israel and which pose no risk to
competition.
The class exemption deals with a broad range of arrangements and provides an exemption from licensing requirements to various operational arrangements, interline and cargo arrangements which do not include an assurance of a minimal amount of flight tickets or cargo capacity and frequent flyer agreements. The Class Exemption also includes "dry" lease arrangements (leasing the plane alone, without the crew) and non-long term "wet" leasing (leasing the plane, crew included), but sets special restrictions on leasing agreements carried out with Israeli air carriers. The class exemption also applies to code sharing agreements, subject to material limitations and restrictions set in it. The type exemption includes transition directives, according to which a binding agreement made prior to the application of the amendment and which is covered by the statutory exemption will not require approval for 9 months from the beginning of the class exemption.
The class exemption is based on a former draft published by the Commissioner on March 2008, to which the Company had a great number of remarks and reservations, which the Company delivered to the Commissioner both verbally and in writing. Even though the class exemption included important and material revisions, inter alia in accordance with the Company's remarks, the Company believes that the wording of the class exemption is still too restrained (mainly as regards the extent of the exemption granted code sharing
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agreements) and it places unnecessarily burdensome regulatory restrictions that may harm the welfare of Israeli passengers as well as the Company's activities. On March 31 2009 the Company submitted a request to the Commissioner for exemption from the obligation to receive the approval of the Business Restriction Court for binding agreements, regarding various agreements between the Company and foreign air carriers, to which the type exemption does not apply, including the Company’s code sharing agreements (hereinafter: “Exemption Request”). The Commissioner’s decisions regarding the Exemption Requests were issued on September 21 2009 (hereinafter: “The Commissioner’s Decisions”).
According to the Commissioner’s Decisions, an exemption was given to the code sharing agreements between the Company and the following foreign air carriers: American Airlines, Swiss Airways, Iberia, Czech Airways, and Thai Air.
In addition, according to the Commissioner's decisions, no exemption was given to the code sharing agreements between the Company and the following foreign carriers: LOT, Austrian, Tandem, Bulgaria Air and Aerosvit, as well as the commercial agreement between the Company and Air India. The Commissioner provided his grounds for refusing the requests on November 3 2009.
Five exemption requests were withdrawn by the Company prior to the Commissioner's decision. These are exemption requests regarding agreements with the following companies: Belavia, Brussels Airlines, Korean Airlines, Tarom and South Africa Airways. Subsequently, the Commissioner issued an exemption for the code sharing agreements between the Company and Air China and with the Turkish airline Atlas Jet (an agreement that was not implemented).
For details regarding new code sharing agreements signed by the Company over the course of 2010 and the status of their approval, see 7.4 above.
The Company's assessment with regard to the impact on the Company's activity as a result of the implementation of such legislation may constitute forward-looking information, as defined in the Securities Law, based on Company assumptions and forecasts. Therefore, the actual outcome of this legislative change on the Company's activity or on its ability to enter into agreements, as stated above, may be significantly different from the outcome expected or implied by this information.
See also Section 9.18.17 below regarding this matter.
Decisions and Proceedings on the Subject of Monopolies
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On October 27, 2005, the Company received notification from the Restraint of Business Commissioner concerning his designation of the Company as the holder of a monopoly in transporting time sensitive (business passengers) and price sensitive (vacation travelers) passengers in the civil aviation market to the destinations of: Johannesburg, Hong Kong, Bangkok and Bombay.
It should be pointed out that the Beijing route, mentioned in the Commissioner's March notification, was not included in his notice of pronouncement as a monopoly. It should also be mentioned that, in March 2005, the Commissioner gave notice that he is examining the status of El Al on 19 routes: Brussels, Marseilles, Paris, Berlin, Munich, Moscow, Geneva, New York, Odessa, London, Vilna, Oslo, Palermo, Turin, Crete, Koss, Rhodes, Stockholm and Dublin.
The following are the key points of the Commissioner's decision, as received at the
Company's offices:
a. The Commissioner classified and characterized consumers in the passenger aviation
sector into two categories: time sensitive passengers and price sensitive passengers. b. The Commissioner determined that, as a rule, for the aviation sector in Israel, the geographic market should be defined based on the departure points and the destination
points of the flight route (city pairs). c. The Commissioner determined that as to substitutability between charter flights and scheduled flights, since charter flights had not been operated to the destinations included in the pronouncement as of 2004, or had existed marginally, there is no need for him to make a decision on this matter. However, he did stipulate that, in principle,
charter flights are not a substitute for business passengers. d. Regarding the substitutability between scheduled flights, the Commissioner has determined that, for vacation passengers, an indirect flight can be, under certain instances, a substitute for direct flights. However, this will apply mainly to long flights when the overall flight time is not extended much longer than the direct flight. Regarding business passengers, the Commissioner determined that, as a rule, an indirect flight is not a substitute for a direct flight, except if it is particularly more advantageous
for them than the direct flight, such as being more frequent than the direct flight. e. The Commissioner stated that for markets denoted in the announcement, El Al is the sole airline operating direct, scheduled flights. He also stated that the Authority approached all of the foreign airlines that were thought to be relevant, and an examination of the market shares in the destinations covered by the pronouncement
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disclosed that El Al holds (as of the date of the examination) the following market
shares: Tel-Aviv – Johannesburg route- A market share in excess of 90%, for both business and vacation travelers. Tel-Aviv –Bombay route – a market share in excess of 80% for business travelers and 80% for vacation travelers. Tel-Aviv – Bangkok route – a market share in excess of 80% for business travelers and in excess of 70% for vacation travelers. The Tel-Aviv – Hong Kong route – a market share in excess of 90%, both for business
travelers and for vacation travelers. The Commissioner also declared that the examinations performed had indicated that, even if indirect flights to other destinations in the same countries were included in the analysis of El Al's market share, this would not alter his conclusion.
On March 30, 2006, the Company filed an appeal with the Business Restrictions Tribunal regarding the Commissioner's decision. In this appeal, the Court was asked to revoke the declaration regarding markets the subject of the decision, in whole or in part. Among the main arguments at the basis of the appeal: the claim that the Commissioner's market definition is incorrect and ignores the characteristics of competition on flights from Israel to long-rant destinations in East Asia; the claim that the Commissioner's analysis regarding the replaceability of demand alone is a lacking and incorrect analysis that ignores the replaceability existing from the supply side despite it being immediate and lacks sunken costs; the claim that the judgment applied by the Commissioner, in activating his authority to declare a monopoly, was essentially incorrect – the Commissioner erred in the manner his judgment was applied and the probable results of his declaration; the claim that even according to the market definitions adopted by the Commissioner, the Company does not fly over 50% of the passengers between Israel and India. In November 2007, a motion was filed that the appeal be summarily dismissed, and in May 2008 the Business Restriction Court rejected the motion in question, stating that relevant market question has yet to be ruled upon in Israel, that one cannot ignore the fact that the practical test adopted in the court ruling is not free of supply considerations and that the need to test the proper market definition is reinforced when the parties cannot agree on the relevant facts. The Court ruled that the Commissioner must treat all airlines equally. At the same time, the Court stated that
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treatment of the equality must be carried out in a different forum and not within the framework of the appeal on the revocation of the declaration. In February 2009 the Court approved the Company's request for an unlimited deferral of the discussion on the appeal in order to study the possibility that the Company withdraw its appeal in light of the extensive changes occurring and expected to occur in the aviation market. The Court permitted the Company to inform it, until the end of its current session, whether it intends to hold a specific hearing on the appeal. Pursuant to this approval, the Business Restrictions Authority filed a motion to revoke the ruling in question and file a response and in March 2009 the Business Restriction Tribunal rejected the Commissioner's request to revoke said decision. See 9.18.17 below for more details. In September 2009 the Restriction of Business Court accepted the Company's request to withdraw the appeal without an expenses order. The Company stands by its claims in its petition, and believes that its declaration as a monopoly holder for the routes denoted in the declaration is erroneous, but in light of the far-reaching changes occurring in the aviation market with the advancement of the "Open Skies" policy by the State of Israel, opening routes to Israel for additional carriers, the appointment of other Israeli carriers as Designated Carriers, the activities of new airlines on routes to Israel, including Low Cost companies, and the trend of mergers and alliances between foreign airlines around the world, the Company believes that from a commercial point of view the need to discuss the appeal and the cancellation of the Commissioner's announcement has become superfluous. For further details see 9.18.17 below. (j) The Consumer Protection Law, 1981.
Amendment No. 13 to the Consumer Protection Law was published on June 30, 2004. The amendment, in essence, revokes the exemption given in the past to services relating to air transport from the requirement to publicize a comprehensive price. According to the amendment, airlines are required to publicize a price that includes all taxes that apply to the service which are collected by them, and every other supplementary payment, which the consumer has no possibility from a practical standpoint to waive in the framework of the transaction. The amendment did not revoke the exemption from the necessity to publicize a price in NIS that was given to airlines. Under the law, the determining rate for payment is the sales rate for transfers and checks. The amendment also stipulates that for international cargo transport, regarding which an arrangement has been established between the air carrier and an international association of airlines, the requirement to state a price in NIS on the basis of the sale rate for transfers and checks will not apply.
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Additionally, the law stipulated that in the case of a "remote sale" of a flight ticket (including by mail, telephone, radio, television, electronic communication of any kind, facsimile, advertising in catalogs or notices, etc.), the consumer is permitted, subject to certain conditions, to give written notice of the cancellation of a transaction and to receive a refund of a certain percentage of the consideration paid, based on the circumstances of the transaction's cancellation. It should be noted that the Consumer Protection Law applies to relationships between a dealer (the Company) and a consumer, and not between a dealer (the Company) and another dealer, but to the best of the Company's knowledge, certain persons intend to attempt to change the legislation on this subject, whereby the law's provisions relating to cancellation of a remote transaction will also apply to relations between the Company and travel agents.
On October 24, 2007, Amendment No. 21 of the Consumer Protection Law came into effect, enabling the courts to award punitive damages of up to 10,000 NIS without proving damage sustained, against a dealer violating a series of legal provisions, including the provision regarding the consumer's right to pay in Israeli currency at the exchange rate stipulated in the law, and the provision related to the consumer's right to cancel a remote sale transaction under certain conditions. According to the amendment, it is even possible to rule increased damages in the event of a serious, repeated or continuing violation.
In February 2009 the Consumer Protection Law, which requires the inclusion, as part of the publication of marketing deals/discounts, of the minimum number of items offered under said deal or discount, came into effect. In accordance with the amendment, as a condition for the deal, a reasonable inventory must be held, taking the nature and scope of the deal into question, at least at the minimum level published.
The 26th Amendment to the Consumer Protection Law was passed March 15 2010 which, among other things, expanded the consumer's right to cancel a remote sale under certain conditions, even after service has already begun to be provided. However, on the matter of hospitality, travel, vacation of leisure services, the Amendment states that cancellation of a remote transaction shall be allowed under the conditions set in the Law only if the date of the transaction's cancellation does not fall within seven days that are not days of rest prior to the date on which the service was supposed to begin.
The Amendment also stated that the consumer will have the right to cancel a transaction carried out as a result of material misrepresentation or abuse of distress, even if the provider wasn't the deceiving party, within a "reasonable period" of time from the transaction and the
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Minister of Industry has the authority to issue ordinances regarding minimum letter size, the ratio between them and the area containing the information and the manner in which they are written and presented, in a document containing information intended for the consumer, including in advertisements.
The Consumer Protection Regulations (Cancellation of Transactions), 2010, which were published on September 14 2010 and which came into effect on December 14 2010, grant the consumer the right to cancel certain transactions and receive a refund, under the conditions detailed in the regulations. Initially, and for a period of twelve months form the publication of the regulations, meaning by March 14 2011, tourism and aviation services outside of Israel are not covered by the regulations, and it was established that up until the date in question the Ministry of Industry, Trade and Employment, which is concentrating treatment of the regulations, must formulate, in conjunction with the Ministry of Tourism and various elements active in the industry, a comprehensive arrangement regarding the cancellation of tourism and aviation services. As this arrangement has yet to be reached as of the aforementioned date, an extension of the exception from the regulations is expected, with the aim of achieving a comprehensive legislative arrangement. Regarding domestic aviation services, including the flights on the routes to Eilat, the regulations came into effect on December 14 2010, and according to them flight tickets can be cancelled within 14 days of the transaction so long as the cancellation is at least 7 non-rest days prior to the first flight date on the ticket
The Company's estimates regarding the effect of legislative changes in the field of consumer protection are "Forward-Looking Information" as defined in the Securities Law. Therefore, the actual outcome of legislative changes may be materially different from the outcome estimated or implied from this information as a result of a large number of factors, including changes in the wording of the legislation, the incidence date and scope of legislative amendments and more.
(k) Legislative provisions applicable to the Company as a “Mixed Company”
(1) Until June 6, 2004, the Company was a “Government Corporation” being “privatized”, as defined in the Government Corporations Law. Starting from June 6, 2004, the Company is a “Mixed Company”, as defined in the Government Corporations Law. In other words, a company no longer a Government Corporation, for which half or fewer of the voting rights at its general meetings, or the right to appoint half or less than its directors, are held by the State. As a practical matter, as long as the State owns shares that provide it with voting
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rights in El Al, the Company will remain a “Mixed Company”. In June 2007, the State ceased being an "interested party" by virtue of its holdings in the Company, although as of a date close to the report date, the Company continues to hold 1.1% of the Company's share capital (in addition to the Special State Share in the Company).
As a mixed company, the Company is subject to some of the provisions of the Government Corporations Law (as provided in Section 58 of the law, which applies various provisions of Government Corporations Law on mixed companies).
(2) Chapter h.2 of the Government Corporations Law authorizes the Prime Minister and Minister of Finance, with the consent of the Ministerial Committee for Privatization, in consultation with the minister responsible for the company’s affairs, to prescribe instructions by decree that are intended to protect the vital interests of the State in connection with a company under privatization. These provisions will apply for a specified period, or in general, they might also apply after the company’s privatization, as stipulated in the decree. The definition of vital interests includes various interests, which in part are similar to those which, in order to protect them, led to the issuance of a Special State Share, and also the avoidance of concentration in the economy, damage to the foreign interests of the State, etc. The position of the Government Corporations Authority is that Chapter 2H to the Government Corporations Law also applies to a Mixed Company. On November 17, 2004, a Government Corporations Decree (Declaration of Vital Interest to the State as to El Al Israel Airlines Ltd.), 2004 (hereafter in this paragraph: the “Decree”) was published under the aforementioned Section 2H. The Decree stipulates that the State has a vital interest with regards the Company, in order to make effective use of vital assets during a time of emergency or for security purposes, to assure the continuation of activities which are vital to the security of the State. The Decree also prescribes that the Company is required to employ, at all times, Israeli air crew members and Israeli ground crews in Israel, properly qualified and licensed in order to operate the “vital assets” (minimal fleet of aircraft; see “Special State Share”), at sufficient numbers for continuous and simultaneous operation of all of the “vital assets” during a time of emergency or for security purposes. The Decree adds that it does not intend to make the Company subject to the provisions of Section 59.i of the Government Corporations Law (which deals with restrictions on the transfer of control), and that the Decree does not intend to detract from the provisions of the Special State Share. See Section 9.11.9 for details of additional restrictions to which the Company is subject under the auspices of the Special State Share.
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(l) Class Action Law, 2006
On March 12, 2006, the Class Action Law was published, which, inter alia, enables a motion to be filed for recognition of a suit against a dealer in connection with a matter between the dealer and a customer as a class action, whether or not they have engaged in a transaction. This provision broadens significantly the causes for filing class actions. The provision will also be applicable as of the publication of the law to motions for class action recognition that were filed before the publication of the law which have not been decided. According to the law, claimants in pending class actions may request to amend the claim and approve it as a class action (or the statement of appeal if the claim is in the stage of appeal) and adding additional causes or extending the existing causes, inter alia, as regards the deceit and abuse in the course of the contractual relations. See 9.14 below for details on class actions to which the company is a party.
(m) Communications Law (Telecommunications and Broadcasts) (40th Amendment), 2008
The amendment to the Communications Law, known as the Spam Law, was passed June 1 2008. The amendment came into effect December 1 2008. The law applies to "advertising" (defined as a message disseminated commercially, the purpose of which is to encourage the purchase of a product or service or encourage the use of money in some other fashion) distributed via fax, email, short text message and autodial, and establishes the obligation for explicit advance consent from the recipient, in writing, including via electronic announcement or recorded conversation, including mailing by the aforementioned methods. In addition, the Amendment sets details that need to be included in the advertisement and other operational instructions. Violation of this law constitutes a criminal violation as well as a civil misdeed leading to the possibility of damages being awarded without proof of
harm caused.
9.11.3 Business Licenses, Building Permits and Employment Permits Some of the Company's activities require the obtaining of licenses under the Business Licenses Law, 1968 or the receipt of permits from various regulatory bodies. As of 2003, the Company has filed requests for business licenses for the activities requiring licenses. Within the framework of the arrangement of business licenses, the Company acts to regularize all of the buildings within its properties, including old buildings, for which the Company does not have buildings permits from the period that the Company was a government company. The Company acts in coordination with representatives of the Ministry of Interior, and hires consultants to assist in the process. In this framework, the Company acts according to an
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orderly Outline Plan to complete the process of obtaining the building permits and conforming them to the existing buildings, and to arrange the licenses for conducting the Company's business. In 2008 the Company received temporary business licenses for all businesses in its fields of activity. The Company is acting to complete the building permit receipt processes and
thus permit the receipt of permanent business licenses.
As of March 2011, 17 permanent business licenses were received. The Company reached agreements with the regional committee regarding the manner in which the terms of the disputed building permits would be upheld and the Company is acting to receive over the course of 2011 building permits for all structures listed in the request, in such a manner so as to allow them to receive permanent business licenses for the remainder of Company businesses for which temporary business license only were granted. The Company is acting in conjunction with the Regional Committee to arrange the licensing of several building constructed prior to the application of the Planning and Construction Law; note that agreement has not yet been reached with the Regional Committee regarding the manner in which business licenses are received for activity requiring such a license inside such structures, insomuch as such licensing is required.
Failure to receive permits and licenses as noted may place restrictions on the Company's activities pertaining to the buildings covered by the permits and licenses in question affect the Company's activity and even cause sanctions to be placed on the Company.
Non-receipt of the licenses and permits or failure to meet the terms set in the permits and the resultant implications constitute forward-looking information as defined in the Securities Law, which includes Company estimates or projections as of the reported date. Therefore, the actual outcome of the failure to receive business licenses and building permits or the failure to receive the proper permits may be materially different from the outcome which is estimated or which might be deduced from this information as a result of a large number of factors, including among other things the actions of the licensing agencies, changes in legislative provisions and the results of legal proceedings.
9.11.4 Commercial Operating License The Company has a commercial operating license (No. 1/88 dated August 2, 1988) granted by the Minister of Transportation under the Licensing Law. The key points of the license are as follows-
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(1) The license holder may not operate aircraft, except under an air operation license granted by the head of the Civil Aviation Authority (hereafter - the "CAA”) (see below as to the operational certificate).
(2) The license holder shall meticulously follow the provisions of every law that applies to the operation of aircraft and all directives that have been or will be prescribed by the CAA.
(3) The license holder shall not operate the aircraft in a manner that might jeopardize national security, public safety and health and flight safety or in a manner that could endanger the public in any other way.
(4) The license holder shall notify the Minister of Transportation of any demand from a foreign country to submit a commercial document or commercial information found outside of the territorial authority of that nation and will not submit or provide such document or information without obtaining the Minister’s consent.
(5) The license holder will ensure that at least 51% of the share capital of the license holder be owned by Israeli citizens and permanent Israeli residents and that at least two-thirds of its directors (board members), including the Chairman of the Board of Directors and the CEO, are Israeli citizens and permanent Israeli residents53.
(6) The license holder will submit to the CAA, upon demand, reports, data or information concerning aircraft operation.
(7) The holder of an operations license will not operate aircraft, unless insurance coverage has been purchased as provided in the license.
(8) The license holder will submit for the approval of the CAA, at least 30 days before it becomes effective, a seasonal flight schedule with detail of aviation routes and frequency of flights on them. A change of a permanent nature in the timetable requires The CAA's prior approval.
53 On May 26, 2003, Section 8 of the commercial operating license was amended so that the percentage of holdings by Israeli citizens was reduced from 76% to 51%, so that foreign ownership could reach 49%. Pursuant to the Special State Share, as long as no other decision has been reached by the holder of the Special State Share or the Company’s Board of Directors, the restriction which will apply to the percentage of foreign holdings of the Company’s shares will conform to the Company's commercial operating license, as it will be at all times. The decision as above on changing the restriction applicable to foreign shareholdings will be reported in an Immediate Report.
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(9) In its scheduled flights under this license, the license holder will transport passengers and goods, to the extent possible, in accordance with the fares and travel and transport conditions prescribed by IATA, or pursuant to other rates, all to be approved in advance by the CAA.
(10) The license holder will transport passengers and goods for free or at cheaper rates if requested to do so by the CAA and according to the terms of the request.
(11) The services that the license holder is permitted to offer and perform are stated in the appendix to the license. The appendix represents an integral part of the license, and the CAA is permitted to change or revoke it. The following are the key points of the appendix:
(a) Transporting passengers and goods on scheduled flights between Israel and points in foreign countries, and between the points themselves. It should be noted that part of the points are not utilized by the Company due to lack of economic feasibility.
(b) Transporting passengers and goods on international charter flights in accordance with the official licensing regulations.
(c) Special assignments subject to the CAA’s consent.
The Minister of Transportation is authorized to revoke the Company's selection for a location(s) that is not utilized by the Company or is under-utilized, and to authorize another Israeli carrier in its stead. See 9.11.7.2 below for details.
(12) The license is valid as long as it has not been revoked or suspended by the Minister of Transportation or the CAA.
9.11.5 Operational Operator's License The Company has an operational license (no. 1/88) which is issued from time to time. A new license came into effect December 31 2010, issued by the CAA in accordance with ICAO
standards. The license stipulates, inter alia, that the operator (El Al) is permitted to act as a “Designated Air Carrier” of large aircraft (under Section 13 of the Flight Regulations - “Operation of Aircraft and Flight Rules”), and to operate international flights to regions defined in the operating specifications and continuing domestic commercial flights, conditional upon the operational restrictions and the conditions listed in the operational specifications that constitute part of the license.
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The aircraft recorded in the license have Israeli registration or foreign registration approved by the CAA, fully owned by the license holder, or has been placed at the disposal of the license holder, with the consent of the Civil Aviation Authority and the Minister of Transportation. The operator has an obligation to report every change in the list of aircraft that appears in the operational specifications, such as sale, purchase, lease to another operator and/or lease from any Israeli operator or foreign operator. The report will be submitted to the operational division and the air capability department at the CAA. For details regarding the amendment of the
Company's operating license in relation to the domestic BGN-Eilat route see 7.1.10.(e) above.
9.11.6 International Regulatory Arrangements The principle of universality dominates civil aviation, whereby every country is sovereign over its own air space, and therefore, each commercial flight to or over any country requires that country's permission. The permission may be in the form of a bilateral agreement (as is customary for scheduled flights) or for a flight(s) on an ad-hoc basis. The international civil aviation industry operates in the context of a system of regulatory arrangements that affect most of the operational aspects of the airlines and, in particular, the subjects of aviation rights, permissible capacity, fare setting, air carrier’s responsibility for damages (physical and property damage) and flight safety standards, security and noise. This system of arrangements is composed of international conventions, laws, regulations and administrative directives, and bilateral agreements. The existing basis for the international regulatory arrangement for international civil aviation is the Chicago Convention of 1944. The International Civil Aviation Organization (ICAO), a United Nations agency, was established in the wake of the Convention. In the framework and under the auspices of ICAO, recommended standards and procedures were prescribed for various areas of aviation activities. The rights to transport passengers and cargo between countries for compensation, permissible capacity and rate setting are organized via air transport agreements or aviation agreements (bilateral), which are based on reciprocity and provide fair and equal opportunities to airlines from both countries.
9.11.7 Air Transport Agreements and the Civil and Aviation Policy of the State of Israel
9.11.7.1 Aviation Agreements- General Most of the aviation rights by which the State of Israel permits a company to transport passengers and cargo on international routes are anchored in aviation agreements between Israel and foreign countries, and a minority (due to the absence of aviation agreements) in agreements
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between aviation authorities or commercial agreements between the Company and the air carrier of the other country, which require the approval of both countries. The principal elements of air transport agreements include, inter alia, the aviation rights granted, appointment of the Designated Carrier and permitted capacity. Until recently, in most aviation agreements between countries, each government appointed an air carrier as a “Designated Carrier” on its behalf to the flights and utilize the traffic rights under the agreement. For details regarding changes in aviation agreements see 7.1.10(b). After the Designated Carrier is selected, it must obtain a permit from the aviation authority of the other country. In order to obtain a permit, the carrier must prove that the substantial ownership and effective control of the air carrier is held by the government of the country or by citizens of the country that selected it as Designated Carrier, and that the carrier meets all international flight safety standards. A new aviation agreement was signed between Israel and the European Union in 2008, which removed the control and limitation restriction from Designated Carriers, as specified in Sections 7.1.10 above and 9.11.7.3 below Most of the aviation agreements to which Israel is a party may be terminated or cancelled with prior notice of one year. After such notice, negotiations are generally held between the two governments in order to set an interim arrangement or new conditions before the expiration of the agreement. Several aviation agreements between Israel and a number of countries were signed over the course of 2010. The various agreements allow the entry of additional Designated Carriers to existing and new destinations, as well as an increase in frequencies allowed the sides' airlines. Note that in 2009 and 2010 as well as at the beginning of 2011 rounds of aviation talks were held between Israel and the EU on the matter of the global ("vertical") agreement, which are to replace the bilateral agreements between Israel and EU members and will not include limitations on the number of carriers, frequencies, capacity and types of aircraft. Additional talks are expected between Israel and EU states regarding the global aviation agreement over the course of 2011. For further details see Section 7.1.10 above. 9.11.7.2 Designated Carrier In aviation agreements, each government grants its counterpart the right to select one of its air carriers as the Designated Carrier. The Designated Carrier is granted the right to carry passengers and cargo between the two countries. At times, the Designated Carrier also receives the right to operate scheduled flights from the second country to a third country (subject to an agreement with the third country).
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Until the second half of the 1990’s, the Company was the sole Israeli Designated Carrier for scheduled flights for the transport of passengers and cargo to and from Israel, with the exception of Sharm-a-Sheikh. The change in the Company's aforementioned exclusive status occurred after licenses were given additional Israeli carriers to act as Designated Carriers to several flight destinations, some in the Company’s place. As of immediately prior to the publication of this report, the other Israeli companies (Arkia and Israir) were appointed Designated Carriers to 30 international destinations from Tel Aviv, 5 international destinations from Eilat and 2 international destinations from Haifa. Sun D'Or was appointed Designated Carrier to 11 destinations, as detailed below: Arkia – on routes between Tel Aviv and Sharm-a-Sheikh, Copenhagen, Stockholm, Amman, Dublin, Tibilisi, Larnaca, Paris, Barcelona, Madrid, Kiev, Krasnodar, Yekaterinburg, Dusseldorf, Munich, Baku as well on routes between Eilat and Moscow, St. Petersburg, Kiev and Paris and Haifa-Amman and Haifa-Sharm-a-Sheikh. Israir - Izmir, Ankara, Riga, Lisbon, Ljubljana, Nice, New York.54, London, Rome, Milan, Berlin, Stuttgart, Geneva, Zurich, Basel, Kiev as well as the Eilat-Moscow route; Sun D'Or – Antalya, Zagreb, Bratislava, Rostov, Sochi, Frankfurt, Minsk, Riga, Lisbon, Almaty and the Eilat-Moscow route. Regarding the implementation of the Open Skies policy, see Section 7.1.10 above. 9.11.7.3 Air Carrier Ownership and Control There is no uniform international arrangement regarding the percentage of the practical ownership and control over an air carrier that must be held by a state or its citizens. The bilateral air transport agreements to which Israel is a party include a provision according to which each of the contracting states maintains the right to suspend or to cancel the permit it gave the airline of the other state, if the “substantial ownership and effective control” are not held by the contracting state or the citizens of the contracting state. The agreements do not include the definitions of substantial ownership and effective control. The accepted practice in the countries of the Western world is to receive the appointment of an airline as Designated Carrier as if it included an affidavit that the required demand for
54 The 2006 appointment of Israir as Designated Carrier (in addition to the Company) to New York for the operation of scheduled flights was for a period of 24 months. The petition filed by the Company before the High Court of Justice against the appointment (as well as the additional petitions filed by the representatives of the Company's employees, including the employee corporation holding Company stock, and the Knafaim company) were dismissed February 2006. Note that in September 2008 Israir announced that it would be discontinuing its flights to New York.
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substantial ownership and effective control is complied with in full, and if it is found that the requirement no longer exists, the state will demand that the situation be rectified. As part of the liberalization policy being instituted by the Ministry of Transportation and implementation of the "Open Skies" policy, a new aviation agreement was signed between Israel and the European Union in December 2008 (“Horizontal Agreement”). The new agreement updates the sections of the bilateral aviation agreements between Israel and EU members referring to the ownership and control of Designated Carriers. The agreement will allow airlines the ownership and control of which is in one of the EU member states to operate scheduled flights from any other EU member, subject to the bilateral agreement; thus, for example, Sky Europe, which is owned by Austrian citizens, may operate scheduled flights between Slovakia and Israel, subject to the aviation agreement between Israel and Slovakia. The commercial operating certificate given El Al specifies that at least 51% of the Company’s share capital must be held by Israeli residents and permanent residents of Israel, and that at least two thirds of the directors (Board members), including the Chairman of the Board of Directors and the CEO, are Israeli citizens and permanent Israeli residents (see Section 9.11.4 above – the Commercial Operating License). In addition, the “Special State Share”, which is anchored in the Company's articles, includes instructions regarding “maintaining the status of the Company as an Israeli company” and “restrictions on the ownership of shares by foreigners” (see Section 9.11.9 above). 9.11.7.4 Capacity Most of the aviation agreements to which Israel is a party (excluding the agreements between Israel and the United States and Great Britain) contain limitations on the maximum permissible capacity or frequency that each airline may offer on the agreed routes in order to assure equal opportunities to the air carriers of the two countries that are parties to the agreement. Additionally, a substantial part of the aviation transport agreements between Israel and other states also stipulate that the capacity must be based on the volume of the traffic between Israel and the other state with which the agreement was signed. Accordingly, the policies of the Ministry of Transportation in the past had been to restrict the flight capacity of the foreign airlines to and from Israel. At the beginning of 2006, and pursuant to the "Open Skies" policies administered by the Israeli Ministries of Transport and Tourism, authorizations were granted to the foreign airlines that operate on the routes to and from Israel to add capacity and frequency. This trend of liberalization and "Open Skies" continued in the following years, and is expected to become more significant with the implementation of the Government's decision on "Open Skies" and the
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continued negotiations in preparation of signing of uniform global agreement between Israel and
the EU member states. For further details see Section 7.1.10 above. 9.11.7.5 Approval of the Minister of Transportation Government Resolution No. 161 states that commercial agreements between Designated Carriers involving the restriction of competition require pre-approval by the Minister of Transport. In 2010 the Minister of Transportation approved several code sharing agreements made by the Company as well as further agreements, as required by law. Regarding legislative changes pertaining to commercial agreements between airborne carriers and the type exemption orders in the area of business restriction as regards these agreements see Section 9.11.2(i). 9.11.7.6 Flight Rates The rates for flights on international routes are published within the framework of the IATA, the international association of scheduled airlines. These fares relate to the interline feature which allow the passenger to purchase a flight ticket from one company and to utilize it in a flight or flights for other companies (within the framework of interline agreements). In addition to the fares within the framework of IATA, which are supervised by aviation authorities, El Al is allowed to set special rates on a unilateral basis. The Israeli Ministry of Transportation does not generally intervene in setting rates advertised by the Group unilaterally, provided that the level of these rates is not higher than IATA fares. IATA is evaluating the companies' fares, and accordingly, publishing flex fares that serve as
interline fares. Under the aviation agreement between Israel and the United States, the carriers are free to set fares, and only if the two governments oppose a proposed rate (a method known as “double disapproval”) due to its being abnormal (exaggerated or within the boundaries of "dumping”), the new rate will not be approved and it may not be offered to the public. Despite the flex fares set by the IATA, most flight tickets and cargo capacity are sold at prices below those that were agreed upon and approved or at conditions different from those prescribed for the various fares. The Company behaves in accordance with general industry practices, while conforming its policies to market conditions and to the actions of the competitors. A substantial part of the Company’s revenues is derived from sales under these conditions. During recent years, a broader variety of flight ticket fares has been created. In all of the aircraft service classes (first, business and economy), there are different types of “reservation classes” (or price classes). Varied demand and different conditions exist for each “reservation class” during different periods of the year.
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Charter flight fares are set in a different manner than those for scheduled flights. Every organizer is committed to pay the air carrier for the capacity (number of seats) they have chartered and, on the other hand, he himself sets the price per seat, generally a package price that includes seats and ground arrangements. Organizers requesting authorization to operate a flight or series of charter flights must state the price offered the public and obtain approval to carry out the flights and their prices from the aviation authorities/administrations of the relevant countries. Airlines, including the Company, collect fuel surcharges, which are updated from time to time in accordance with increases and decreases in jet fuel prices. In addition, the airlines charge a security surcharge as part of the flight ticket price.
9.11.8 Israel’s International Civil Aviation Policy Over the years, the Government of Israel and ministerial committees (privatization or social and economic) have approved a series of decisions pertaining to Israel’s international civil aviation policies. Resolution 323 HC/14 of the Ministerial Committee for Social and Economic Matters in the matter of "Aviation Policies of the State of Israel on Scheduled Routes" was passed in May 2003, as detailed in 7.1.2.(b) above. A resolution was passed on the "Encouragement of Competition in Civil Aviation to and from Israel" in August 2005, following which the Aviation Services Law was amended (see 9.11.2 B above), and Resolution 441 on the matter of encouragement of competition in civil aviation to and from Israel was passed in September 2006, and the decision made by the Minister of Transportation to establish a public committee to examine the "Open Skies" policy (see Section 7.1.10 above). In recent years, the Ministry of Transportation has begun implementing a policy of increasing liberalization in the aviation industry, the "Open Skies" policy, with the objective of encouraging and increasing tourist traffic to Israel by increasing competition between airlines. As provided above, on January 27, 2008, Government Resolution No. 3024 was adopted, on the matter of the State's participation in the security expenses of Israeli airlines, including an amendment of Government Resolution No. 353 (HC/14) on the matter of the State of Israel's policy on scheduled routes. On August 24 2008 Government Resolution 4032 was passed and on February 1 2009 Government Decision 4462 was passed, both of which are also relevant to the issue. See Sections 7.1.2 and 7.1.10 above for further details.
9.11.9 The Special State Share 9.11.9.1 Close to the publication of the 2003 Prospectus, the Company issued a “Special State Share” to the State. The rights granted to the holder of the Special Share are listed in the Company’s
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Articles of Association, which also detail the vital interests of the State in the Company, which must be protected by means of the Special State Share. These vital interests are:
Preserving the Company as an Israeli company so that it will remain subject to Israeli law, including legislation that allows equipment to be mobilized for security purposes and legislation for times of crisis, and so that the conditions needed to maintain its operating
license and traffic rights should be maintained.
Safeguarding the possibility of ensuring that the operating capability and ability to fly passengers and cargo by the Company will not fall below the capacity detailed in the Company’s Articles of Association, in order to provide the State with effective use of vital assets in times of emergency or for security purposes, as will be determined from time to
time by those authorized to do so, as detailed in the Company’s Articles of Association.
Preventing parties hostile to the State of Israel or persons who might cause damage to the vital interests of the State or to the foreign or security interests of the State or to the Israel's aviation ties with foreign nations, or persons who are found in and/or likely to be found in substantial conflict of interest that could damage one of the areas detailed above, from being
an interested party in the Company from influencing its management in any other way.
Fulfilling the security directives and arrangements that apply, or that will apply as a result of Government resolutions or under any law, to the area of security of flights, passengers, baggage, cargo and mail, in Israel and abroad, including in relation to the Company’s operations abroad and to the cooperation needed from local authorities abroad in these areas; in the area of security classification of employees and suppliers of services to the Company; and in the area of security over classified data and protection of security
information.
The holder of the Special State Share is the State of Israel via a minister or ministers, as stipulated by the Government or by a ministerial committee, from time to time or for a
specific purpose.
9.11.9.2 In order to protect these vital interests, instructions were prescribed for the Special State Share
as to the following matters:
Instructions for the purpose of preserving the Company as an Israeli company, including
restrictions as to the citizenship and security clearance of Company executives;
Instructions on the matter of compliance with security directives and arrangements;
Instructions on t rights to security information and classified information in the Company;
Instructions on the matter of the Company’s discussions of security issues;
Instructions on the matter of Company discussions on security matters;
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Instructions on the matter of observing minimal flight capacity55 - the Company is not permitted to carry out certain transactions relating to its aircraft without consent of the
55 a. Transfer of vital assets will be invalid as regards the Company, shareholders, and any third party without the prior written consent of the holder of the Special State Share if, as a result, the usable, fit, and ready for- immediate-operation fleet of aircraft will be reduced (including due to any law provision) or the operational capability and flight ability of the Company will be reduced (including due to provision of any law) below what is itemized in one of the following sub sections: (1) At least 4 cargo aircraft as to which the minimal cargo transport capability from the United States to Israel is 320 tons daily; (2) At least 3 broad hulled passenger aircraft as to which the overall minimal passenger transport capability from the United States to Israel is 1,000 passengers daily; (3) At least 6 medium and small aircraft as to which the overall minimal passenger transport capability from Europe to Israel is 2,000 passengers daily. b. Should there be a significant change in the relevant circumstances, the holder of the Special State Share will be permitted, with the Government’s authorization, to decide to increase the number of vital assets and/or to change their quantity and/or the composition of the assets on a permanent basis or for a specific matter, all for up to half of the number of aircraft owned by the Company at that time. This decision will not be made before the Company is given a fair opportunity to express its position to the Government - the total of the vital assets after increasing the number of vital assets according to this paragraph is limited to up to half of the number of aircraft owned by the Company at the time of the decision. A change in the composition of the vital assets will be made in the framework of the composition of the current fleet of aircraft owned by the Company at the time of the decision. The Company will not be required to acquire new aircraft under this sub-paragraph (b); c. Despite what appears in sub-paragraph (a) above: (1) An aircraft leased by the Company from an Israeli corporation, which is lawfully incorporated and registered in Israel, will be deemed owned by the Company, as long as that aircraft is owned by such corporation and Israeli law specifically applies to the lease agreement regarding the terms of lease and the aircraft. (2) The holder of the Special State Share will be permitted, at the request of the Company, to approve the lease of an aircraft by the Company from a non-Israeli entity, as long as the State's vital interests are protected and the agreement contains the proper provision which grants the State the authority to use the aircraft, including mobilizing it at any time under Israeli law, all to the satisfaction of the holder of the Special State Share. d. As long as the provisions of sub-paragraph (a) above are not complied with, the Company will not purchase and/or own shares or means of control, at a rate providing it with control, in corporations which own, directly or indirectly, including by subsidiaries, aircraft or auxiliary equipment, other than with the consent of the holder of the Special State Share. e. Without detracting from the above, should a vital asset be transferred in contravention of this section, and the sale cannot be revoked and/or the situation cannot be restored to what it was within a reasonable time, the Company will be obliged to immediately purchase a substitute vital asset and to cover the expenses incurred by the State due to the temporary absence of the vital asset. f. In a case in which the holder of the Special State Share refuses the Company’s request to transfer a vital asset, an arrangement will apply to indemnify the Company for the damages it incurred, principally, that the State will indemnify the Company in monthly payments to the extent of the leasing fees which the Company would have received, had it leased the vital asset when the monthly indemnification began, in the open market to a willing lessee, the transfer of which was refused, as will ultimately be determined by the appraiser(s) appointed by the State and the Company. g. Should the period in which the holder of the Special State Share refuses the Company’s request to transfer the vital asset exceeds 6 months, or in the State's judgment, at an earlier date, the State will purchase the hindered asset at the price which the Company would have received had it sold the hindered asset to a willing purchaser at the time of the purchase, as will ultimately be determined by the appraiser(s) appointed by the State and the Company.
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holder of the Special State Share if, as the result of such transactions, it might reduce the Company's flight capacity below the level that was set by the Special State Share; in this regard note that in December 2008 the Company received the consent of the holder of the Special State Share for the decommissioning of 2 cargo and in July 2009 the Company issued a request to decommission the remaining two cargo aircraft as well as lease a 747- 400 cargo plane from a non-Israeli corporation. For details see 8.1.2 above. Instructions
on the matter of reviewing Company documents and data;
The acquisition of influence or status in the Company requires the State's consent - in accordance with the Company's Articles of Association, transactions involving the Company’s shares at a certain level will not grant any right derived from holding and/or from purchasing shares in the Company without the prior written consent of the holder of the Special State Share (the State through the ministers designated by the Government)56. The Articles of Association stipulate a detailed arrangement on the subject of the manner
h. Without detracting from the above, should the holder of a specific fixed lien on an aircraft or auxiliary equipment, including the loading equipment necessary to protect flight operation capability, wish to realize it (subject to the approval of the lien under the terms which were stipulated), the Company and the lien holder will so notify the holder of the Special State Share at least 45 days in advance, and the State will be permitted, at its sole judgment, and after giving prior notice of one week of its intention to the Company and the holder of the lien, to sustain the charge against which the asset had been pledged as collateral. If the State sustains the charge in accordance with the contents of this section, it will be permitted, if the holder of the lien had the right to return to the Company and receive payment from it, including expenses that were connected with sustaining the charge, and the lien will serve it to secure this right. The contents of this section will be included, as an obligation of the parties to the State, in every agreement for the lien on an aircraft or auxiliary equipment, including the loading equipment that is necessary to protect flight operation capability, which will be entered into after the Special State Share was issued, as a condition of the lien agreement with the Company, its shareholders and any third party. 56 (a) Holdings of 5% or more of the issued share capital of the Company; (b) holdings of 15% of more of the Company's issued share capital (also if agreement had been received in the past for an holding percentage below 15%); (c) holdings of 25% or more of the Company's issued share capital (also if agreement had been received in the past for a holdings percentage below 25%);(d) holdings of 40% or more of the Company's issued share capital (also if agreement had been received in the past for a holdings percentage below 40%); (e) holdings that grant “control” of the Company even if agreement had been received in the past as to the holdings percentage (though not agreement as to “control”). For this purpose, control is defined in accordance with the Securities Law. In addition, the largest shareholder, at any time, will be deemed the controlling interest; (f) holdings or acquisition as a result of which “foreigners” will own 24% of the Company's issued share capital, or a higher proportion, which might, in the opinion of the State or in the opinion of the Company’s Board of Directors, cause damage to the Company’s flight rights and/or to its operating license, which will be and/or has been given by the State, in its sole judgment (the commercial operating license given to the Company stipulates that at least 51% of the Company’s share capital must be held by Israeli citizens and permanent Israeli residents). In any event, the holdings by foreigners of the Company's shares exceeding 49% of the Company’s issued share capital is a proportion which might damage the Company’s flight rights; (g) every security and/or pledge transaction of the Company’s shares, which, following its realization or invoking of underlying rights, the security holder or the pledge holder is likely to own shares out of the Company’s share capital in the proportions mentioned in sub paragraphs (a) to (f).
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of submitting the request for obtaining consent to own shares in the Company, in the
event such consent is necessary as above.
Instructions on the matter of obtaining approval to vote at the General Meeting: the right to vote at the General Meeting requires the approval of the Company. Approval to vote at the General Meeting will not be given when circumstances exist that require the consent of the holder of the Special State Share, and such has not been granted. The articles of association also prescribe special instructions in cases in which reasonable concern exists that the ownership of the Company’s shares by foreigners might cause damage to the
Company's flight rights or to its operating license. 9.11.9.3 Every change, including an amendment or cancellation, in the provisions of the Memorandum of Association and Articles of Association (incorporation) of the Company which relate to the rights granted and/or ascribed to the Special State Share and to its holder, will be ineffective as regards the Company, its shareholders and any third party, without the prior written consent of the holder of the Special State Share.
9.11.10 Regulation The Company's maintenance system has been certified by the Israeli Standards Institute under quality standard ISO 9001/2000. In addition, the Company's maintenance system has been certified as an inspection institute, approved by the Civil Aviation Authority in Israel, the U.S. Federal Aviation Agency (FAA) and the certifying authority of the European Union's association (EASA). To be clear, the EASA certification is for the Company's line maintenance array. Over the course of 2010 the Company underwent an IOSA (IATA Operational Safety Audit) inspection. The Company has complied with all requirements for the receipt of an extension to the Standards Association stamp granted in January 2009, and in October 2010 the Company received IOSA certification for an additional two years. This is an international standard in the field of airline operations, safety and QA. Likewise, starting 2008 the standard constitutes a condition for IATA membership. The receipt of this certification places the Company in the forefront of world airlines as far as flight safety is concerned.
9.11.11 Quality Control El Al's maintenance system is monitored by an internal quality control system that operates according to the manufacturer’s specifications and a maintenance program approved by the Civil Aviation Authority.
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9.11.12 Security Arrangements The civil aviation industry, particularly on routes to and from Israel, could be targeted by various parties, particularly terror organizations. The Company takes extraordinary security measures, under the guidance of the governmental body responsible for this area. Until the early 1980s, the State had covered all of the Company's direct and indirect security costs. Over the years, the State has instituted a policy of reducing the rate of its participation in security expenses. In accordance with a decision by the Government of Israel, the Company participates in security expenses at a rate of 50%, since January 1, 2003. During 2002, the rate of participation was between 30% and 34.14%, while in 2001, it was between 25% and 30%. As detailed above, on January 27, 2008, the Government passed Resolution No. 3024, which prescribes the rate of the State's participation in the security expenses of Israeli airlines at 80% of the total direct expenses for the operation of existing and future international routes, in an attempt to enable these companies to contend, to the extent possible, with fair and equal competition opposite foreign airlines, keeping in mind the importance of liberalizing the civil aviation industry, while recognizing the need for the existence of a strong Israeli aviation industry. The decision revokes Government Resolution No. 2325 dated July 30 2002 (which set a participation rate of 80%). See Section 7.1.2 above for further information on the Government's January 27 2008 resolution. As described in Section 7.1.2, a petition to the High Court of Justice was filed by the Company following this decision. In addition, Government Resolution no. 4032 was passed on August 24 2008, following which the petition was amended. Government Resolution no. 4462 was subsequently passed on February 1 2009. For details see 7.1.2 above. On May 13 2009 the Company filed an amended petition according to which the Company asked that the court issue an order to the respondents that they provide an explanation as to why Resolution 3024 should not be implemented verbatim and in full for the period between January 1 2008 and December 31 2008, so that Section 2 of resolution 4032 does not apply to this period, and alternately, which Resolution 3024 should not be implemented verbatim and in full up to the date on which the decision to dismiss was reached, meaning up to August 24 2008, an amendment that is necessary, inter alia, in order to limit the dispute and the discussion to a specific period of time (and not in relation to other issues deriving from resolution 4032 and Resolution 4462, regarding which the Company reserves its rights). A hearing before a panel of judges was set for the petition for July 2011
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The following details the direct costs for the security of the passengers, aircraft and employees of the Group (El Al and Sun D'Or), divided between the portion financed by the Group and the portion financed by the State:
State Financing The Group’s Total (In (In Thousands of Share (In Thousands of Dollars) Thousands of Dollars) Dollars) 2010 66,390 41,068 107,458 2009 69,430 38,398 107,828 2008 52,401 43,603 96,004
Note that in accordance with the Government Resolution regarding the existence of regular aviation relations with neighboring countries (Egypt and Jordan), higher participation rates of the State of Israel were set for these rights, in order to maintain flights on these routes. The Company also has indirect security costs that are caused, inter alia, by flying security personnel in the seats of paying passengers. Beginning from October 2001, the Company has been allowed to collect a supplement for insurance and security of $8 per flight leg. In January 2009 the Israeli Government approved a project for the installation of electro-optic protection systems in passenger aircraft. The meaning of the government resolution is that the Israeli airlines, including the Company, will be required to participate in the project in question (including installation in Company aircraft). The manner in which the Company will participate in financing the costs involved in operating the system and its various derivatives, its maintenance and its installation has yet to be established and the source of the financing for this decision is being discussed between the State and the Company. The Company is currently negotiating with Elbit Systems Ltd. for the latter to act as subcontractor for installing and maintaining the system. In addition, the Company provides security services to Israeli airlines, in return for refunding the Company's aforementioned costs. Accounting for these services was arranged by use of a "payroll price list" (dated 1999) published by the Ministry of Finance and revised from time to time. The Company has requirements pertaining to liabilities, compensation and responsibility of the State and the Israeli airlines in the area of security as well as demands for compensation for claims with these elements. The Company is acting in conjunction with the Ministry of Finance, the Ministry of Transportation and Road Safety, the General Security Services and the Israeli
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Airlines to realize its requirements. At the same time, discussions were held at the Ministry of Transportation for the examination of a new flight security management mechanism. On May 16 2010 Arkia filed a motion before the High Court of Justice that the Company be compelled to grant security services to Arkia flights to Aqaba (Jordan) after the Company had not been granted letters of indemnity for theses services. The Court rejected Arkia's motion. In November 2010 the Minister of Transportation and Road Safety announced his intention to establish a government security authority to handle the subject of aviation security. Following this announcement, in November 2010 the Company announced that it intended to cease providing security services to other Israeli airlines and shall provide security services to itself and to Sun D’Or until the establishment of a national security authority, starting March 31 2011. In March 2011 the Company responded to the Minister of Transportation and Road Safety and announced that it would continue providing security services to Arkia and Israir after April 1 2011. The Company is currently holding talks with government offices in order to examine the manner in which security services are to be provided by the Company to itself and to the Israeli airlines and the economic, operational, legal and insurance aspects of this activity. The information provided above regarding the manner in which security services are provided, the scope of the State's participation in the Company's security expenses and the actual financing of existing and new expenses constitutes forward-looking information, as defined in the Securities Law. This information is supported, inter alia, by the Company's assessments and is based on the realization of existing decisions. The actual change in the Company's performance could be significantly different from forecasts, due to many factors, including regulatory changes and enforcement of legislative regulation by the State authorities.
9.11.13 Operations during Times of Emergency and for Vital Purposes Under existing law, during times of emergency, the Israeli airlines, including the Company, may be operated for purposes of national defense or public security or maintaining supplies or vital services. In addition, arrangements exist with the Company as to flights for the security of the State, or at times of emergency, as well as flights for other extraordinary purposes, including the consideration to be paid for them on a commercial basis. The Law for the Registration and Mobilization of Equipment for the Israel Defense Forces, 1987, empowers the Minister of Defense, if he is convinced that the defense of the State so requires, to declare by decree the need to mobilize equipment (including aircraft). The law relates to equipment owned by the Company during times of emergency. The law obligates the
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State to pay usage fees for the equipment that was mobilized, and, if the equipment was damaged during the period of emergency - compensation for the damages. The Law for Work Services during Times of Crisis, 1967, empowers the Minister of Labor to certify an enterprise as “a vital enterprise”, and after such certification, to mobilize all of its workers for vital work service. The Company has been certified a “vital enterprise”. The approval is renewed from time to time at the Company’s request. The current certification is effective through December 31, 2009. Supervision of Goods and Services Law, 1957, grants the minister so empowered by the Government, the authority to issue a “personal decree” or a “general decree” for the performance, inter alia, of a “vital action” for the defense of the State, for the security of the public, to maintain regular supplies or services. This action includes, among other things, the obligation to operate an enterprise or to perform any regulated service.
9.11.14 Public Commission for Evaluating Civil Aviation Safety in Israel During 2007, a public commission was appointed to evaluate civil aviation safety in Israel, headed by Brigadier General (ret.) Amos Lapidot. In December 2007, a detailed report was submitted to the Minister of Transportation and Road Safety, indicating a series of serious flight safety deficiencies, including the need for improved technology in the command and control systems at BGN, a deficient ability by the Civil Authority in Israel, and a shortage of manpower, the need to update legislation in the field of aviation and the need to train and monitor air traffic controllers. On December 19 2008 the U.S. FAA announced that it would be lowering the State of Israel's aviation safety rating to Category 2 (for further details see Section 9.11.2.(h) above).
9.12 Material Agreements On February 3 2010 the Company signed a framework agreement with Maman, which operates a cargo terminal at Ben Gurion Airport, regarding the receipt of terminal services
from Maman. According to the agreement, Maman grants the Company, for the duration of the agreement, discounts on regular rates prior to the signing of the agreement pertaining to terminal services. The agreement shall be in effect (retroactively) from the beginning of 2009 to the end of 2010, with El Al retaining the right to extend the agreement for three additional one- year periods followed by an additional three-month agreement. El Al's right to extend the agreement by any of the aforementioned extension periods is subject to the fact that in the year preceding the extension the amount of El Al cargo treated at the Maman terminal did not drop below a certain threshold. At the end of all of the extension periods, insomuch as
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Maman's current license to operate the terminal is extended, El Al shall be entitled to
extend the agreement by an additional four years. According to the agreement, subject to the requisite approvals, Maman shall allocate shares to El Al to the amount of 15% of Maman's stock capital, with half of them allocated prior to signing the agreement, a quarter at the beginning of 2011 (subject to the first extension of the agreement) and an additional quarter at the beginning of 2012 (subject to the second extension of the agreement). El Al shall be precluded from passing on shares allocated in the above manner for a period of 15 months from allocation. In addition, El Al shall be granted options to purchase Maman shares at a rate constituting 10% of Maman's issued capital, exercisable within six years of issue at an exercise price of 22.33 million NIS (in the event of exercise within first three years after granting) or alternately 23.625 million NIS (in the event of subsequent exercise). In addition, it was agreed that the parties strive to tighten their business cooperation past the area of cargo handling in Israel. On February 18 2010 the Company's offices received a letter from the Restraint of Trade Authority addressed to the CEOs of the Company and of Maman (the "Letter"). In its letter, the Restraint of Trade Authority informed them that the arrangement between the parties according to which Maman would grant the Company rate discounts and issue options and shares may seemingly constitute a binding arrangement as per Section 2 of the Restraint of Trade Law (the "Law") and may also constitute a misuse of stature by the owner of a monopoly as per Section 29a of the Law and therefore the Restraint of Trade Authority suggested that at this stage the parties avoid acting in accordance with the agreement until the legalities of the arrangement are fully resolved. In September 2010 the Company received a letter from the Restraint of Trade Authority, according to which the Authority confirmed that the wording of the clause (as detailed above) included in the draft addition to the framework agreement provided by the Company and Maman to the Restraint of Business Authority, is acceptable to the Authority, and that after the parties sign the addition to the framework agreement including the clause in question, the Restraint of Business Authority will have no objections to the implementation of the framework agreement. The clause of the addition draft to which the Restraint of Business Authority refers in its letter sets various restrictions, as required by the Authority, on the Company's involvement in the affairs of a specific Maman subsidiary (Laufer Aviation GHI Ltd.) and on the transfer of certain information pertaining to the subsidiary in question to the Company.
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Therefore, on September 19 2010 the Company and Maman signed an addition to the framework agreement, the signing of which constituted a term for the removal of the Restraint of Business Authority’s objections to the implementation of the framework agreement. On November 3 2010 Maman’s special general meeting approved a material private offer, pursuant to which Maman’s securities would be allocated to the Company in the following manner: up to 7,000,000 ordinary shares worth 1 NIS NV each constituting up to 15% of Maman’s issued and paid-up capital, as well as options exercisable as regular shares at a
rate close to 10% of Maman’s issued and paid-up capital. Following this, as of immediately prior to the approval of the report the Company was issued 4,436,620 ordinary Maman shares, constituting 11.25% of Maman’s issued and paid- up capital. Furthermore, the general meeting approved the appointment of Mr. Amikam Cohen, Chairman of the Company's Board of Directors, as member of Maman’s board of directors, starting November 7 2010, and the appointment of Mr. Yehuda (Yudi) Levi, Deputy Chairman of the Company’s Board of Directors, as member of Maman’s Board of Directors, starting January 1 2011. On November 1, 2010, the Company informed Maman of the exercise of the option to extend the commitment period according to the framework agreement, to December 31 2011. For further details on the impact of the Maman agreement on the Company's financial results, see Note 6.a to the Financial Statements. In November 2010 the Company signed a framework agreement with the State of Israel for the purchase of flight tickets for official trips by state employees and other official representatives, appointed by government units and offices. The agreement shall remain in effect for two years, with an option to extend it with the consent of the parties up to a maximum of two additional years and the right to revoke it at any time with 30 days advance notice. In accordance with the agreement, the Company shall be given an advance- based discount, during ticketing and payment, at rates depending on the type of class, as well as other benefits set in the agreement.
In January 2011 the Company signed agreements with the Jewish Agency to fly in new immigrants and transport messengers. The agreement shall remain in effect for two years, with the option to extend it with the consent of the parties up to a maximum of two
additional years and the right to revoke it at any time with 90 days advance notice.
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In accordance with the immigrant's agreement, the Agency shall pay El Al for each immigrant flying on a regular-scheduled El Al flight a special rate defined in the agreement for that destination and class. In addition, the Agency may contact El Al for the purpose of ordering special flights, in which the entire capacity of the plane (seats and/or cargo) shall be placed at the Agency’s disposal, under conditions agreed upon by the parties for each such flight. Furthermore, the agreement grants benefits to the
Agency and to immigrants flying with it.
In accordance with the messengers agreement, the Agency shall pay El Al for flying messengers and their family members flying with them pursuant to their duties a rate set by the parties. In addition, the agreement grants the agency and its messengers
additional benefits
On January 1 2010 a clearing agreement was signed with American Express Travel Related Services, Inc. for a 5-year period (retroactive from January 2009). The agreement provides a clearing solution for online sales as well as for sales conducted directly in Company
branches in Israel and around the world.
For details regarding the aircraft purchase agreement with Boeing see 7.11 above.
In addition, the Company is party to agreements with regard to employees and their rights (see 9.4 above), agreements for the lease of real estate (see 9.1.1 above), agreements for the lease and financing of aircraft (see 7.11 and 8.10 above), loan agreements for a designated purpose (see 9.8.5 above), various agreements with airlines (see 7.2, 9.11.7 and 9.13 above), and insurance agreements (see 9.2 above). The Company also has an obligation to indemnify Company executives. For further details see Section 29a of Chapter D (Further Details on the
Corporation's Business).
9.13 Cooperation Agreements The Company is party to agreements with other airlines (interline agreements) which permit passengers on scheduled flights, subject to certain restrictions, to use flight tickets issued by one airline for the services of another airline. In addition, the Company is party to code sharing agreements, which permit an air carrier to market flights of another air carrier, as if they were its own flights. See Sections 7.2 and 7.4 above for details. For legislative changes that could have a material effect on the Company's ability to enter into code-sharing agreements see Section 9.11.2(i). For details on the code sharing agreements signed with Air China, Siberia Airlines, Bulgaria Air, Armavia and Aeorsvit see 7.4 above.
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Additionally, the Company has various operational agreements with various airlines, which include, inter alia, technical operations arrangements, leasing arrangements, aircraft maintenance and spare part agreements, mutual assistance in emergencies, the supply of aviation equipment and more. The Company also has arrangements with airlines regarding lounges, regarding frequent flyer collaborations, accounting for connecting flights, on matters of reservations and transport agreements (passengers or cargo).
9.14 Legal Proceedings As of December 31 2010, $151 million in legal claims have been filed against the Company, for which the Company has listed a $7.4 million provision in its Financial Statements, based on the advice of the Company's legal counsel. Legal claims not quantified in monetary sums have also been filed against the Company. The sum of the provision in the Financial Statements includes provisions for non-quantified claims, as estimated by Company management.
The following are the most significant pending claims in which the Company and/or its subsidiaries are involved: 9.14.1 In October 2005, a claim was filed in the Supreme Court of Ontario, Canada against the Company and additional defendants by a former employee of the Company for alleged sexual harassment and sexual assault. The sum of the claim was approximately $2.2 million Canadian ($2.2 million U.S.). According to International Financial Reporting Standards (IFRS) implemented by the Company since January 1 2008, the Company has made a provision for this claim in the Financial Statements based on the advice of
its legal counsel. For details see Note 27.c.(c).(2) to the Financial Statements. 9.14.2 In June 2006, a suit was filed against the Company and the State of Israel - Ministry of Finance in the Tel-Aviv District Labor Tribunal, by 94 claimants, who had been employed by the Company and who took early retirement between the years 2001- 2003. The claimants in their suit have appealed for declaratory relief/order of performance to amend their retirement agreements in a manner in which the retiree will receive the early pension stipend, including fringe benefits, until the legal retirement age, instead of until the age of 65; alternatively, the claimants appealed to revoke the retirement agreements. Alternately, the claimants appealed to revoke the retirement agreements. The claimants quantified the claim at 18,223,584 NIS ($5.1 million). In
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January 2009 the court ordered that this claim be consolidated with two additional claims. On January 6 2009 it ruled that the claimants submit their position regarding the limitation of the causes of the claim. In October 2010 a partial ruling was issued, stating that early retirement agreements must be reinterpreted, so that instead of 65 years of age they shall be considered valid until the age of 67. The partial ruling also stated that within 60 days of the ruling, basic agreed-upon calculation principles shall be submitted to calculate the sums. Subsequently, the Company filed a request to appeal the partial ruling before the National Labor Court, which was rejected in January 2011. The Company made a provision for this claim in its Financial Statements, based on the advice of its legal counsel. For details see Note 27.c.c.(4) to the Financial Statements. 9.14.3 On December 20, 2006, the Company received a letter from the European Competition Commission (the "Commission") at its head office, which contained a request for information in connection with an investigation being carried out by the Commission in connection with activities that, allegedly, cause damage to competition in the sector of air transport services for cargo. The letter stated that the Commission has information regarding extensive contacts that took place between airlines and other entities with regard to various price increments and other matters such as cargo transport rates. In the context of the letter, the Company was requested to transmit data and documentation regarding the Company and its cargo activities, starting 1995. The Company has provided its response as requested by the Directorate's letter, while conducting an internal review of its cargo pricing practices. According to publications by the Directorate and by several foreign companies, in December 2007 the Directorate sent a "statement of objection" to several airlines with regard to the aforementioned inquiry, including claims of alleged breach of competitive statutes of the European Union (this is an administrative procedure in which the Directorate reserves the right to issue significant financial fines). The Company has not received the aforementioned letter of claims, and is not among the companies to which the letter of claims was addressed. On November 9 2010 the Commission published an announcement of its decision to fine 11 airlines for a total sum of €800 million for the operation of a “global cartel” influencing cargo services in the European Economic Area and in particular, for coordinating activities pertaining to fuel and security surcharges, in the period between December 1999 and February 2006.
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The Company was not a recipient of this announcement, and therefore was not found liable and was not fined for this violation. 9.14.6 On February 28, 2007, the Company received a statement of claim filed at the United States District Court for the Eastern District of New York in the matter of air cargo transport services rates. The Company was included as a defendant in the statement of claim, along with 38 other airlines, which alleged that the defendants were partners in a conspiracy to fix prices for air cargo transport services, beginning in 2000, while violating competition and other laws in Europe and the United States. The claim was filed in the name of entities that purchase air transport services, directly and indirectly and it also included a motion for class action recognition. The claim includes a request for damages in an unspecified amount as well as additional remedies. The Company joined a mutual defense team featured other airlines being sued. In light of initial settlement talks and based on the advice of its legal counsel, the Company has listed a provision for this claim. See Note 27.c.(b).(3) to the Financial Statements for details. 9.14.5 In January 2007, a suit was filed against the Company in the Jerusalem District Court, along with a motion for class action recognition, in the amount of about 483.4 million NIS ($136 million). The plaintiffs allege that the collection of a security levy in the amount of $8 per flight leg from passengers on flights not carried out by the Company itself, but by other airlines, in the framework of code-sharing agreements with the Company, represents consumer misrepresentation, breach of the agreement with him, absence of good faith, and unlawful gain, this as on these flights, the plaintiffs allege, security or protection services were not provided identical in level and quality to the security services provided by the Company. The plaintiffs requested that the Company be compelled to pay each of these passengers the sum of $8 as well as damages of 500 NIS for emotional distress and loss of benefit. As agreed upon by the parties and ratified by the Court, a revised motion was submitted to approve the suit as a class action. A response was filed by the Company and on August 19 2009, the Court rejected the motion in question and ruled the petitioners liable for expenses to be paid the Company. An appeal was filed before the Supreme Court on October 22 2009. In the opinion of Company management, based upon the advice of its legal counsel, the Company is not expected to be found liable in this claim. No provision was made for this claim in the Financial Statements. See Note 27.c.(a).(2) to the Financial Statements for details.
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9.14.6 On August 24 2008, the South Korea Fair Trade Commission (hereinafter: the "Korean Commission") presented the Company with a request for information pertaining to an investigation the Korean Commission is holding regarding possible violations of Korean competitiveness rules in the field of air cargo shipping for the period starting 1999. The Company received additional requests for complementary information from the Korean Commission and provided its responses to the requests in question. To the best of the Company's knowledge, the Korean Commission has conducted an investigation on a series of airlines. According to the publications of a number of foreign airlines, in October 2009, the Korean antitrust authority sent out an "inspection report" to several airlines pertaining to the investigation in question containing claims on the matter of alleged violations of Korean antitrust laws. The Company has not received the inspection report in question and to the best of its knowledge is not numbered among the companies to which the inspection report was addressed. In May 2010 the Korean Fair Trade Commission published a press notice in which it announced its intention to fine 21 airlines in 16 different countries, for an accumulated sum of 119.5 South Korean wons, based on findings regarding involvement in a cartel in the matter of a number of cargo routes to and from Korea. The Company was not a recipient of this announcement, and therefore was not found liable and was not fined for this violation. 9.14.7 On May 7 2009, the Company received a copy of a motion to approve the filing of a derivative claim (the "Motion”) and the claim itself, which were filed before the Tel Aviv-Jaffa District Court (hereinafter: the "District Court”). The claimant, who claims to hold 4,500 Company shares (constituting 0.001% of the Company's share capital) has filed a motion that the Court approve the claim as a derivative action against a number of executives serving in the Company in 2003 and who no longer serve in the Company (the "Claim”), on the basis of the argument that these executive allegedly violated their prudence obligation toward the Company by involving the Company in fixing one or more price component in the field of airborne cargo shipping to and from the United States in the relevant period and that, he claims, they caused damage to the Company estimated at at least $15.7 million U.S., this on the basis of the plea bargain between the Company and the U.S. Department of Justice as reported by the Company. The claim was preceded by a motion to file a derivative claim, which was rejected by the Company after the Company's Board of Directors decided that it would not be in the Company's best interests to file such a claim against former Company executives.
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The Company filed its response to the motion in September 2009. On August 27 2009, the executives filed a motion to join the action (hereinafter –the "Motion to Join”). The motion to join was rejected by the District Court. After the attempt made by the executives to change the District Court’s ruling by way of a motion to clarify their ruling was not successful, on December 26 2010 they filed an appeal to the Supreme Court in Jerusalem. In its February 10 2011 ruling, the Supreme Court accepted the executives’ appeal and ruled that the motion to join is to be ruled upon by the District Court. A date for a hearing on the motion to join is to be determined. Over the course of these proceedings and prior to the discussion on the request, the claimant passed away. On January 12 2011, the claimant’s representative announced that his heirs have stated their intent to take his place and continue with the proceedings. A date for a hearing on the motion is to be determined. 9.14.8 In March 2010 a civil suit was filed before the Jerusalem District Court by Mishpacha Newspaper Ltd. and Mishpacha Magazine (2005) Ltd. against a cargo agent and against the Company for a sum of 6.5 million NIS (of which a sum of $1 million is claimed against the Company), containing claims regarding bills of lading issued for cargo shipments. The Company made a provision for this claim in its Financial Statements, based on the advice of its legal counsel. 9.14.9 In March 2010 a lawsuit was filed against the Company as part of arbitration proceedings in the U.S. to the amount of $700,000 on behalf of a hotel that had provided hospitality services to the Company's air crews, which include arguments regarding accounts that require settlement between the parties. The parties have decided to engage in arbitration with the intent of solving the dispute. The Company made a provision for this claim in its Financial Statements, based on the advice of its legal counsel. 9.14.10 In October 2010 a suit was filed before the Rishon Lezion Magistrate’s Court by the Israel Aviation Authority against the Company to the amount of 1.8 million NIS; in its suit, the IAA claimed that as part of a project for the construction of a new sewage treatment facility in BGN, the Company undertook to construct preliminary facilities and perform sewage treatment up to a specific date, so that the Company facilities may be connected to the new facility. The claim was that the Company had violated its obligations and as a result, the IAA was forced to continue operating old oxygenation ponds, causing it costs and damages. A statement of defense has been filed. The
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Company made a provision for this claim in its Financial Statements, based on the advice of its legal counsel. 9.14.11 In February 2011 the Company was provided with a copy of a motion to approve the filing of a claim as a derivative claim as well as a copy of the derivative claim. The motion was filed to the Economic Department of the Tel Aviv District Court by a holder of 5,000 Company shares (constituting 0.001%). Note that the shareholder had submitted two demands to the Company, which had been rejected by the Company’s Board of Directors. According to the motion, the court was asked to approve a derivative claim to the amount of 22,800,000 NIS against Israel (Izzy) Borowitz, Tamar Moses Borowitz, Amiaz Sagis, Nadav Palti, Amnon Lipkin Shahak, Yigal Arnon, Eyal Rosner, Shimon Katzanelson and Yehoshua Ne’eman, who had served on the Company’s Board of Directors in 2005 during the ratification of the employment contract of the former Company CEO, Mr. Chaim Romano. The motion claimed, inter alia, that the aforementioned board members were negligent in determining and approving the yearly incentive bonus for Mr. Romano, who had served as Company CEO between 2005 and 2009, as well as regarding the Company’s reports on the formula of the bonus in question. The Company has yet to file is response. For details regarding the Securities Authority’s audit see 9.4.16 above.
The following are material claims in which the Company and/or the subsidiaries were defendants, and which concluded during 2010 or by a date near to the approval of the report: 9.14.12 In February 2008 a suit was filed before the Tel Aviv Labor Court against the Company and against the New General Workers’ Histadrut by 24 Company captains, all of them over the age of 65, some of whom are retired and some are employed by the Company. The plaintiffs demand that the Court declare their right to the fact that the Company shall take steps to receive permission from the CAA allowing their employment in training and testing positions over the age of 65 and assign them to training and testing positions as needed. The claim against the Histadrut is that the Histadrut is violating their fair representation obligations toward the plaintiffs, inter alia, due to the Pilots’ Committee’s refusal to negotiate on their behalf. Alternately, the Court is asked to require the defendants to negotiate with the plaintiffs regarding their
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continued employment and the terms of said employment. A statement of defense has been filed by the Company, hearings have been held and in June 2010 the Court dismissed the suit. 9.14.13 In February 2007, a claim was filed against the Company and other parties in the New York State Supreme Court by an employee of the Company for allegations of sexual harassment by a Company employee in the U.S. In August 2010 a settlement was reached between the parties, in which a monetary sum was paid the claimant.
9.15 Goals and Business Strategies On September 20, 2005, the Company's Board of Directors approved the Company's strategic program for the next five years and the principles of implementing it, entitled "El Al 2010", the ultimate goals of which were designed to improve business results by increasing sales and improving profitability. The goals of the program included: (a) significant improvement in customer service by enhancing the customer's experience in all of the Company's activities according to the needs of specific fields, focusing on the business customer and dealing with his special needs, emphasis on developing customer loyalty, improving the treatment of the incoming tourist and establishing an integrated service center; (b) cultivation of operational excellence, in dealings with customers and other processes, as well as by striving to reduce the level of fixed assets relative to revenues and investment in systems and processes for optimal management of the organization's resources; (c) business innovation and initiative, including initiatives for developing traffic to and from Israel, development of additional revenue sources in the areas of maintenance, tourist services and ground services, development of BGN as a transit airport for continuing flights and conversion into a global company, advancement of cooperation with aviation wholesalers and development of the Internet as a distribution channel; (d) outfitting, including investment in modern equipment for long range routes, gradual rejuvenation of the aircraft fleet in accordance with financing terms, repayment ability and market development, and weighing continued outfitting based upon market developments; (e) improvements in the areas of cargo and maintenance, through continued growth in cargo operations while, at the same time, evaluating the operational structure, strengthening the ability to sell maintenance services and examining the development of maintenance as a profit center for the Company, and investigating cooperative arrangements with Israeli and international airlines for expanding ranges and areas of activities; (f) cultivation of human resources by means of updating labor
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agreements, developing and updating training systems, employee compensation and incentives, and embedding the culture of a private entity in a competitive market. The Company continued to act in accordance with its strategic plan in 2010, while adapting the strategic plan to accommodate the various factors influencing the Company, including the geopolitical situation and its impact on the aviation industry and on passenger traffic to and from Israel, changes in jet fuel prices and increased competition. In January 2010 the Company employed the services of a professional consulting agency specializing in providing consultation services to airlines throughout the world, for the implementation of a consulting project in specific areas to detect opportunities to improve the Company's profitability. Interim results have been submitted to Company management and include a series of recommendations for implementation primarily in commercial, quality and service areas, with the aim of developing sources of income and new partnerships, and achieving the Company's potential in the fields of passengers, cargo and tourism. The key points of the recommendations in the commercial areas dealt with the field of yield management and included among other things a recommendation to upgrade and replace the RMS system (see 7.1.5 above), recommendations regarding the route network, in the field of organizational structure in the trade division and sales costs. The Company has implemented some of the recommendations regarding its route network, yield management and organizational structure. Furthermore, decisions were reached during the reported year regarding the Company’s jet fuel hedging policy (for details see Chapter B of the Report of the Board of Directors).
The implementation of the strategic plan in 2010 was reflected, among other things, in: a. Adapting means of production to the demand environment and profitability of the routes by
adapting capacity, in order to optimize the route network. b. Continued improvement in customer service throughout the entire service chain, while providing an appropriate response to various populations, carrying out customer preservation actions and developing collaborations benefitting customer service. c. Expanding the various services provided by the Company in Israel and abroad, including expanding the route network by signing code sharing agreements and interline agreements with other airlines, improving existing agreements and activity in the field of tourist services and vacation packages (for details see 7.6.3 above). d. Operating domestic flights, with activity starting in August 2010 on the BGN-Eilat route.
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e. In operating a leased 747-400 cargo airplane (as detailed in 8.1.2 above), expanding the cargo volume in the holds of passenger aircraft, expanding cargo routes by adding a flight
to Hong Kong and improving service and professionalism among Cargo Division workers. f. In making decisions in the field of equipment acquisition, including the Company's decision regarding the purchase of new 737-900 aircraft and carrying out aircraft leasing transactions (for details see 7.11 and 8.10 above). g. Continuing the development of sources of income in maintenance areas while providing services to airlines, aircraft manufacturers and other maintenance centers, including expanding and extending the agreement with Nepal Airlines Corporation to grant maintenance services, expanding the amount of customers for the repair of 737NG and 757 landing gear and expanding maintenance works with Boeing. h. Continuing with the implementation of technological systems, including by expanding the use of the Amadeus system at stations and designated systems in various operational areas, including in the field of cargo (for details see 7.1.5 above). i. Continuing with its comprehensive approach to matters of safety and the environment, including air pollution and noise hazards, in which the Company received various approvals and opens itself up to regular inspection. For further details see 9.10 above. Implementation of the business strategy presented above by the Group constitutes forward- looking information as defined in the Securities Law, and is based upon the Group’s assumptions, assessments and forecasts as to its business environment, which could change, in whole or in part, from time to time, thus effecting how it is actually implemented by the Group and the achievement of the program's goals. Accordingly, actual results, in whole or in part, may not be realized as above, be realized in part or to be materially different than the results that are estimated, derived or implied from this information, inter alia, for the reasons detailed below. Application of this strategy may be affected by regulatory changes that may require actions be taken, inter alia, as regards the route network and the aircraft fleet. In addition, implementation of the strategy is subject to the implications of global economic, political and/or security changes on environmental demands, on increased competition as a result of the State of Israel's aviation policy and the expansion of the activity of low cost airlines or aviation pacts in the Israeli market and the planned implementation of an aviation agreement ("open skies") with the EU. In addition, implementation of the strategy could be affected by
fluctuations in jet fuel prices, which constitutes a substantial part of the Company's expenses.
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It is the Group's practice, from time to time, to evaluate the conformity of the strategic program and its goals to developments in the Group's business environment, as it did in 2010 ,as detailed above. The Company is working on the development of a medium and long-range business strategy, which is expected to express the Company's goals and strategies for coming years, while adapting its current strategy to developments in world markets and in international aviation.
9.16 Developments Projected for the Coming Year The Group intends to continue studying the adaptation of its activities to trends and developments occurring in the Group's business-economic activity environment and in global aviation. The chief challenge of the aviation industry in 2011 is the expected influence of the political instability in the Middle East, which influences jet fuel process and which may also influence demand in the area as well as the Japanese natural disaster and associated events that may influence traffic to East Asia, on global financial markets and on the aviation industry. These trends and changes require a constant in-depth examination of the Group's activities, including the combination and profitability of the Group's route network in the fields of passengers and cargo. In addition, the Group's activity over the coming year is also expected to be influenced by changes in regulation affecting the activity including the "Open Skies" policy, as described in Section 7.1.10 above. The goals of the strategic program will be accomplished by attentiveness, inter alia, to the manner in which the Company's outfitting plan is being realized and to the strengthening the Group's ability to cope with and prepare for toughening competition, and striving to improve business results in 2011 by enhancing the mix of revenues, improving yields, implementing organizational efficiency measures and cutting expenses. The information concerning the forecast of developments during the coming year represents Forward-Looking Information, as defined in the Securities Law. The information is supported, inter alia, by the Company’s assessments, forecasts or intentions as of the report date. Therefore, the actual developments during the coming year may be, in whole or in part, materially different than the developments assessed, derived or implied from this information, as the result of a large number of factors, including those listed in Section 9.15 above and the
risk factors described in Section 9.18 below.
9.17 Financial Data on Segment-Based Reporting For data on segment-based reporting see Note 37b to the Financial Statements. For explanations regarding developments in these segments, see Section a.5 of the Board of Directors Report.
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9.18 Discussion of Risk Factors Like other airlines, the operations of the Company are affected by several external and internal factors that could lead to material changes in its profitability (positive or negative). The risk factors may be divided into macro risks, industry risks and risks that are unique to the Group. The major risk factors are: Macro Risks
9.18.1 Political or Security Events or Terrorist Acts Political or security events or terrorist acts in the world or in the region have an immediate, negative effect on the demand for passenger and cargo transport and influence the Company’s economic condition and volume of activity. The risk is that the impact on the Company's revenues will be caused as a result security and geo-political events in Israel or in target destinations.
9.18.2 Exposure to Currency Risks
Most of the Company’s revenues and expenses are denominated in or linked to foreign currency (mainly the US dollar). The Company is exposed to a rise in the value of the shekel relative to the dollar with respect to current wage expenses and other liabilities denominated in shekels in the Company's balance sheet, principally with respect to termination of employee-employer relationships and vacation provisions. The revaluation of the shekel vis-à-vis the dollar increases the Company's current expenses and also increases, in dollar terms (without effecting cash
flows), the Company's obligations related to termination of employee-employer relations.
Furthermore, natural internal protection exists for other foreign currencies (pound sterling, euro, rand etc.) carried out by comparing payments and receipts in each currency. In years when the volume of the receipts is not significantly different from the volume of payments in European currencies, the mixture serves as internal protection against exposure to these currencies, whereas in years in which a material difference exists between the payments and receipts and exposure is created for the Company with those currencies (mainly the euro), the Company considers the need to invest in financial derivatives to reduce the exposure created. For details regarding the actions taken by the Company for hedging the exposure to currency risks see Section b.1.(5) to the Board of Directors’ Report, as well as Note 31e to the Financial
Statements.
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9.18.3 Changes in Economic Status The aviation and tourism industries are sensitive to changes in economic activity affecting the demand for passenger and cargo transport. The expense structure of the aviation industry, which includes a high component of fixed expenses, makes it very difficult to implement procedures to conform the Company's supply to changes in short-term demand. During periods of an economic slowdown, the demand for air transport is reduced for different reasons, and excess capacity and unutilized labor and flight equipment is created. Consequently, the Company’s economic position is worsened, as reflected in its business results. The global financial crisis has led to the collapse of financial bodies and the nationalization of other bodies by various governments. The crisis has led to a global slowdown and even to a recession, which has caused a sharp drop in the demand in international passenger and cargo traffic (for further details see Sections 6.1, 6.2 and 7.1.3 above).
9.18.4 Outbreak of Epidemics and Natural Disasters Outsides factors such as natural disasters, fires and earthquakes, epidemics and so forth, may harm the Company's normal course of operations. Outbursts of epidemics (such as the "Swine Flu") and natural disasters (such as the Icelandic volcano and Japanese tsunami) have a negative effect on passenger traffic to the disaster areas and therefore may have a similar negative effect on the Company's business results. Note that the Company's actions during the Icelandic volcano events and the resulting impact they had on international air traffic were indicative of the Company’s fortitude and its ability to deal with crises.
9.18.5 Exposure to Variable Interest Rates The Company finances part of its investments using credit from banking institutions. The Company’s loans and most of its deposits are in dollars. Most of the loans bear variable interest and, accordingly, any change in interest rates might materially affect the Company’s financing expenses and cash flow. In order to reduce exposure to this risk factor the Company has entered into interest risk hedging agreements. See Section b.1.(4) to the Board of Directors’ Report for details with regard to the actions taken by the Company to hedge the exposure to variable interest rates. These hedging agreements may expose the Company to changes in the fair value of said hedging agreements. For further details see Notes 7, 25 and 31f. to the December 31 2010 Financial Statements.
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Industry Risks
9.18.6 Jet Fuel Prices Jet fuel is a significant component of an air carrier's operating expenses. Jet fuel prices are subject to sharp fluctuations. Between 2004 and July 2008 the price of jet fuel rose at a substantial rate, while starting from the third quarter of 2008, sharp decreases were listed in jet fuel prices. Jet fuel prices rose again in 2010. The Company's profitability may be significantly impacted by increases or severe fluctuations in jet fuel prices. The Company employs hedging activities for part of the forecasted jet fuel consumption. This policy could change according to circumstances. As a result of this policy the Company faces an accounting risk due to fair value changes as well as the requirement for restricted deposits. Due to the great weight of jet fuel in the Company's operating expenses, every increase in jet fuel prices negatively affects its operating expenses and operating results. For details regarding the actions taken by the Company for hedging its exposure to changes in jet fuel prices see Section b.1.(3) to the Board of Directors’ Report as well as Note 31g to the Financial Statements.
9.18.7 Changes in Competition The aviation industry is characterized by a high level of competition, which becomes more acute during periods of excess capacity. The entry of additional charter airlines into the market, the entry of additional foreign scheduled carriers into the Israeli market or an increase in capacity of existing foreign carriers, the entry of additional Israeli carriers into the market and the appointment of additional Israeli carriers as Designated Carriers (in the fields of passengers and cargo), the entry of additional charter and low cost airlines, and the granting of operating licenses to additional Israeli airlines in the passenger and cargo areas cause a worsening of competition in the Israeli aviation industry, a situation that may reduce the Company’s share in the industry's operations, create excess capacity, lower the level of passenger and cargo transport prices and hurt the Company’s business results. This trend of stiffening competition intensified over recent years, as it did in 2010 with the entry of new airlines and the increased capacities and frequencies of airlines operating in the Israeli market (see 7.1.2, 7.1.10 and 7.8 above for details). In addition, changes in international agreements, including the implementation of an aviation agreement (the Horizontal Agreement) between Israel and the EU, signed in December 2008, and the progress of talks on the matter of the global agreement with the European Union (Open Skies) which is designed to replace all bilateral agreements with EU member states and remove restrictions the number of carriers, frequencies, capacity and type of aircraft may have a negative impact on the Company's activities as a result of intensifying
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competition and multiple carriers and capacity. Furthermore, it should be stated that the increase in flight capacity of foreign airlines in the passenger aircraft field, also led to a substantial increase in the capacity of cargo flown in the holds of passenger aircraft of these companies to and from Israel, and exacerbated the competition also as relates to the activity of cargo aircraft. See 7.1.10, 7.8, 8.1.10 and 8.7 above for further details.
9.18.8 Seasonal Influences The operations of the Company are seasonal by nature and are focused during peak periods (see Section 7.9 above). Tourism traffic, mostly during the summer season and at holidays (Jewish and Christian), is higher than the annual average. The cargo transport field is also characterized by high seasonal fluctuations. As the component of the capital expenditures and fixed expenses out of the total Company expenses is significant, the impairment of operations during the peak season (due, for example, to political and security events) or the inability to obtain replacement aircraft, even if concentrated over a relatively short period, can have a substantial negative
effect on the business results of that year.
9.18.9 Government Resolutions on Aviation and Licensing the Company as an Air Carrier (a) A change in the Government’s policy with respect to the Company’s status as a Designated Carrier for all or part of the routes on which the Company serves as Designated Carrier could materially affect the Company’s financial results, according to the type of route. Additionally Government resolutions could change the Company's position and have a negative effect on its financial results (see Sections 7.1.10 and 7.1.2 above for details on Government resolutions on the subject of state participation in security expenses and the Israeli aviation policy in the matter of appointing Designated Carriers and related legal proceedings).
(b) The Company’s operating licenses as an air carrier and its rights as such are conditional upon the practical ownership and the effective control being in Israeli hands. The Company's ability to always know the extent of foreign ownership of its shares is limited to the records it administers, and, accordingly, a situation may exist in which the foreign owners of shares did not report their holdings to the Company (purchase or sale) and were not recorded in the shareholders' registry, so foreign ownership will exceed the permissible percentage or will be less than the percentage recorded in the shareholders’ registry, without the Company being aware of it. If the Company becomes aware that foreign ownership exceeds the permissible percentage, it will be able to act in
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conjunction with the Special State Share to reduce the percentage of foreign ownership. Should it be unable to do so and the foreign holdings in the Company’s shares exceed the permissible percentage, the Company could lose its status as a Designated Carrier. However, whenever the holder of the Special State Share and/or the Minister of Transportation believe that the actual control and the ability to direct the Company’s operations remains in the hands of the Board of Directors, two thirds of the members of which, including the Chairman, the CEO and Company officers, are Israeli citizens and permanent Israeli residents, the risk is minimal that the Company will lose its status as Designated Carrier just because of the rate of foreign ownership in the Company’s shares.
(c) For details regarding the cancellation of the operational license of subsidiary Sun D’Or see 9.7.1 above.
9.18.10 Operations in an Industry with a High Fixed-Cost Structure The Company operates in the aviation industry, which has a structure of relatively high fixed costs and relatively low profit margins. Therefore, small changes in the level of revenues or expenses could have a direct effect on whether there will be earnings or losses.
9.18.11 Noise and Environmental Restrictions on Flight Operation Every change in restrictions on night operations at BGN or other airports from/to which the Group flies and each additional restriction or prohibition on the operation of aircraft due to air pollution, noise, etc. might have a material effect on the Company's business results. A number of alternatives are presently being examined as to a change in the hours of operation at BGN and the permissible noise levels, which, if they are carried out, could materially affect the Company’s business results. (See Sections 9.10.2 and 9.10.3 above for further details). For details regarding the petition of the Holon municipality regarding the nighttime operating hours of Ben Gurion Airport and its possible impact on the Company's activities, see 9.10.2 above.
9.18.12 Effect of the Operations of Low Cost Airlines on the Israeli Market Airlines with a low production cost structure (low cost carriers) have increased their market share substantially in recent years, principally in the United States and in Europe. This growth has negatively affected veteran airlines with higher production cost structures, and has caused a decrease in their market share and a drop in their yield due to fare reductions as the result of competition. Most low cost airlines specialize in short flight legs. Under the terms of new aviation agreements signed in recent years airlines have began operating in Israel with a format similar to
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that of low cost airlines that have not operated on Israeli routes before, along with low cost airlines such as EasyJet (for details see Section 7.1.10 above). The entry of these and other airlines into the Israeli market could have a negative effect on the Company's business results, due to the increased capacity offered by these airlines at reduced prices. See Sections 7.1.1, 7.1.4, 7.1.8 and 7.1.10 above for additional details.
9.18.13 Impairment of Flight Safety or Flight Security In order to maintain flight security, the Company upholds security arrangements in accordance with the instructions of the appropriate governmental agency. In order to maintain flight safety, the Company carries out the instructions and provisions stipulated by the relevant entities, including the instructions of the manufacturer and the Civil Aviation Authority. Damage to the Company's flights and/or its customers and/or its installations and/or its employees, due to an event connected with flight security and/or flight safety is liable to have a material negative effect on the Company's operations, inter alia as a result of harm done to reputation, the loss of revenues and customers and the Company's exposure to legal action.
In addition, the Company has a “crisis event” array, assembled and practiced in accordance with guidelines set by the IATA, which examined and approved the array in three separate inspections in 2006, 2008 and 2010. The Company conducts “crisis event” training exercises at the Company level once per period and revise its procedures according to global developments in the field (booklets, conferences and professional media).
For details regarding standardization and licensing requirements applying to the Company's activity see 9.11.2 and 9.11.10 above.
9.18.14 Aviation Regulation The Company's activities and its ability to expand the scope and layout of its activity, is dependent, among other things, upon various regulatory approvals granted by authorities in Israel and around the world. The absence of proper licensing and the failure to uphold international or local regulations may lead to increases in Company costs, to competitive inferiority in comparison with the Company's competitors and may harm the Company's regular course of activity. The FAA's lowering of the flight safety rating for the State of Israel to Category 2, as occurred in December 2008, may have a negative impact on the Company's activity, inter alia in light of the fact that although the declaration in question refers to the safety rating of the State of Israel, the implications of the declaration are harmful to the Company's
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operations to and from the U.S. as well as damaging to its reputation. For details concerning the declaration and its impact on the Company see Section 9.11.2.(h) above. During the reported year, regulatory changes were made to aviation legislation applicable to the Company and proposals were raised for changes to laws and regulations in the field of aviation regulation, for which the legislative process has yet to be completed, including the new Aviation Law, 2010; for details regarding aviation regulation see 9.11.2 above.
Risks Unique to the Company
9.18.15 Costs of Maintaining Flight Security A the Company is required to maintain security arrangements that are determined by a governmental body and it bears security expenses over which it has no control, most of which do not apply to foreign, competing airlines, this situation hurts its profitability, its competitive ability, and the development of a route network. The Government passed several resolutions in 2008 and 2009 altering the rate of the State's participation in Israeli airlines' direct security costs. For details regarding the Government resolutions and legal proceedings initiated by the Company on this matter see Section 7.1.2 above. The rate of the State's participation in the Group's flight safety expenses, changes in the extent of safety measures the Company will be forced to take (due to security events or attempted attacks), as well as whether the Company will be forced to discontinue or limit its flights to additional destinations as a result of safety reasons, may have a material impact on the Company's operating results. For details regarding steps pertaining to flight security costs see 9.11.12 above.
9.18.16 Restrictions on the Future Receipt of Credit and Failure to Meet Financial Criteria The Company has undertaken towards its long-term loan providers to maintain a proper collateral ratio between the unpaid loan balance and the collateral pledged to the bank, as stipulated by each agreement. In addition, the terms stipulated in certain agreements relating to loans taken by the Company include the bank's right to demand immediate repayment of the loan balances owed to that bank if, in its opinion, based on reasonable criteria, a change had occurred that adversely affects the Company’s financial position or its operations or its business or its financial ratios, in a manner endangering or potentially endangering its ability to repay the bank loans. The failure of the Company to comply with financial covenants stipulated in the loan agreements, including with regard to the decrease in the market value of the collateral, and/or the demand for immediate repayment of Company loans by the banks, might have a negative effect on the Company's business results. In addition, single borrower and group of
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borrower limitations may apply to the Company, as well as limitations on the transfer of control and on changes to its ownership structure, taking the extent of the credit and the identity of the Company's controlling party into account. For details regarding credit limitations see Section 9.8.2 above.
9.18.17 Business Restrictions In light of legislative changes in the field of business restrictions, the competitive ability of Israeli carriers, among them the Group, may be damaged, which may have a negative impact on the Group's activities due to regulatory restrictions on the existence of international agreements in the Group's areas of activity or the non-approval of these agreements (existing or new) by the Restriction of Business Authority (for details see Section 9.11.2.(i) above). The gaps between Israeli antitrust law (according to which advance approval is required for certain commitments and a risk exists that this approval will not be granted) and antitrust law elsewhere in the world may impact the competitiveness of Israeli airlines, in particular in light of the mergers, acquisitions and aviation pacts common in international aviation. In addition, legal proceedings in the field of business restrictions to which the Company is party, including the class action suit conducted in the U.S. regarding price coordination in airborne cargo transportation, may have a negative impact on the Company's financial results. For further details on the matter of legal proceedings in the field of business restriction see Section 9.14 above.
9.18.18 The Municipal Status of BGN From time to time, the addition of BGN to the jurisdiction of the city of Lod is taken under consideration. If the transfer of BGN to the jurisdiction of any local authority should become a reality, the Company's expenses might increase (due to the payment of municipal taxes that up to now have not been paid), and the matter will negatively affect its business results.
9.18.19 Labor Relations Every interruption of operations of an air carrier due to sanctions or a strike causes a non- recoverable loss and damage to customer confidence. The situation in the industry and the increasing rate of competition necessitate continued efforts to increase Company efficiency and to improve service to the customer public. These depend on stable labor relations in the Company, on the employees' identification with the Company and on readiness to cooperate and in an understanding with management.
Although the “industrial calm” in the Company has been maintained since 1983, excluding a small number of disruptions, the efficiency expressed in structural changes, in the reduction in
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the number of personnel (with the emphasis on permanent employees), and the reduction of labor costs, could cause a shake-up, even for a short period, in the delicate texture of labor relations in the Company. This could cause damage in the immediate term and hurt the Company’s goodwill over the longer term, and it might have a negative effect on the Company's business results for that year and thereafter. Additionally, there could be difficulty in utilizing business opportunities and dealing with changes due to limitations in the labor agreements. For details on the collective labor agreement signed November 2 2008, the proceeding pertaining to separate representation for the pilot sector among employee representatives and the special collective agreement for temporary employees, see 9.4.7 above.
9.18.20 Legal Proceedings The Company is a party to legal proceedings, including a claim the court was asked to recognize as a class action in Israel that may cause it to be charged with material amounts that cannot be estimated, and for which no provision has been made in the Company’s financial statements. Furthermore, a proceeding is underway in the United States to approve a claim as a class action, on the grounds of fixing air cargo transport service prices, which may lead to material financial charges. The results of these proceedings may have a material impact on the Company due to their results (see 9.14 above for further details regarding these proceedings).
9.18.21 Restrictions Due to Certain Provisions of the Special State Share The restrictions relating to maintaining minimal flight capacity, especially for cargo aircraft, and the prospect of the State demanding to increase the minimal flight capacity with which the Company must comply, diminish operational flexibility and impose burdensome obligations (assurance of fitness). The indemnification in these cases does not cover the Company’s expenses. In addition, the Government Corporations Law gives the Company the authority to prescribe instructions intended to protect the vital interests of the State with respect to the Company, this according to decrees under Chapter 2H of the Government Corporations Law. Such decrees might restrict the Company's business judgment and, as a result, could hurt its financial results. See Section 8.10 above for information concerning the request from the holder of the Special State Share with respect to the reduction of the fleet of cargo aircraft in its possession.
9.18.22 Dependence on Aircraft Manufacturer The Boeing Corporation manufactured all of the aircraft in the Company's service. The discontinuation of Boeing's operations could cause temporary operational difficulties for the Company. The Company has a material dependence on Boeing both with respect to spare parts
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as well as with respect to engineering support. At the same time, the Company estimates that the likelihood of the discontinuation of this support is low.
9.18.23 Dependence on Regular Operations at the Home Airport (BGN) Most of the Company’s operations are carried out at its home airport, BGN. Therefore, an interruption or breakdown in the normal operations of BGN and/or changes in the policies of granting takeoff and landing authorizations (slots) at the central airports in which the Company operates might have a material negative effect on the Company’s operations. Renovation works began on a BGN in 2010, a process expected to last 4 years, during which BGN will contain a single functional runway. In addition, a proposal exists that Ben Gurion Airport be opened for departures throughout the night. Changing the operating hours and changing the activities to accommodate a single runway may have a material impact on the Company's operational abilities and financial results.
9.18.24 Flights on the Sabbath and Jewish Holy Days The Company continues to operate pursuant to a 1982 Government resolution and does not operate passenger flights on the Sabbath and on Jewish holidays. For details regarding the agreement between the Company and the Committee of Rabbis for Sabbath Observance see Section 7.10 above. Non-fulfillment of the understandings regarding flights on the Sabbath and Jewish holidays, or a change of the Company's policies with respect to this subject, could cause a dispute with this customer sector, which could affect the Company's results due to a consumer boycott.
9.18.25 Information Systems and Information Security The current operations of the Company, the business activities and the services that it provides are based upon information systems and databases. The risk exists of mishaps and failures in the operation of the Company's information systems, which may lead to the shutdown of crucial systems or the absence of support for a certain period. The lack of an appropriate backup site may lead to damage to the Company's activities and to its database. In addition, disruptions in the adoption of the new Amadeus ordering system at the Company's stations (Stage B of the system's implementation may be harmful the Company's regular course of activities. The Company is currently in advanced stages of setting up an IT backup facility.
The following table presents the risk factors described above according to their nature (macro risks, industry risks and risks particular to the Group), which have been ranked, as estimated by the Group’s management, according to their effect on the Group’s business as a whole - major, moderate and minor
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effect. The Company’s assessment as to the ranking of the risks was determined taking into account the likelihood of the event and the measure of damage that might be caused to the Group, should the event take place.
Extent of Risk's Effect on the Company
Minor Effect Moderate Effect Major Effect
Macro Risks Political events, security events or V terrorist actions
Exposure to currency risks V
Changes in the economic situation V
Natural disasters and epidemic outbreaks V
Exposure to variable interest risks V
Industry Risks
Jet fuel prices V
Changes in competition V
Seasonal influence V Government resolutions on aviation
matters and the Company's licensing as V an air carrier Operations in an industry with a high V fixed-cost structure Noise restrictions and environmental V matters Effect of low cost airlines operation on V the Israeli market Impairment of flight safety or flight V security
Aviation regulation V
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Extent of Risk's Effect on the Company
Minor Effect Moderate Effect Major Effect Risks Unique to the Company
Minor Effect Moderate Effect Major Effect Costs of maintaining flight security V Restrictions on receipt of credit and
failure to meet financial criteria V
Business restrictions V
Municipal status of BGN V
Labor relations V
Legal proceedings V Restrictions due to provisions of Special
State Share V
Dependence on aircraft manufacturer V Dependence on regular operations at V home airport (BGN)
Saturday and religious holiday flights V Information systems and information V security
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______
2010 ANNUAL REPORT
CHAPTER B DIRECTORS' REPORT
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El Al Israel Airlines Limited. Report of the Board of Directors on the State of the Corporation's Affairs For the Year Ending December 31, 2010
Table of Contents
Chapter Page
1. General
1.1. Changes in International Financial Standards (IFRS)…………………..b-5
1.2. The Company and its Business Environment……………………...……b-5
1.3. Holdings of Company Shareholders…………………………………….b-6 a. Explanation of the Board of Directors on the State of The Corporation'sAffairs
a.1. Financial Position (Consolidated Financial Statements)………..…………..b-7
a.2. Analysis of El Al’s Business Results
a.2.1 Market Data……………………….…………………………………b-10
a.2.2. Company Operating Data………..…………………………………..b-11
a.3. Statement of Operations Data For the Year Ending December 31, 2010
(Consolidated Financial Statements)………………………………………b-12
a.4. Influence of Changes in Exchange Rates on the Company’s
Employee Benefits Liabilities……………………………………………..b-16
a.5. Segment Reporting
a. General…………………………………………………………………b-18
b. Analysis of Revenues and Results by Operating Segments……………b-19
c. Analysis of Revenues by Destination…………………………….……b-19
a.6. Seasonal Factors……………………………………………………………b-20
a.7. Liquidity and Financing Sources…………………………………..………b-20
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b. Exposure to Market Risk and Management Thereof
b.1. Qualitative Reporting on Exposure to and Management of Market Risk….b-22
b.2. Linkage Basis Report………………………………………………………b-31 c. Aspects of Corporate Governance
c.1. Charitable Contributions and Community Work…………………………..b-33
c.2. Directors with Accounting and Financial Capabilities…………………….b-33
c.3. Disclosure Regarding Independent Directors………………………….…..b-34
c.4. Disclosure about Internal Auditor of Reporting Corporation….……..……b-34
c.5. Disclosure Regarding Independent Auditors' Fees…………………..…….b-37
c.6. Disclosure in the Report of the Board of Directors Regarding the Financial Statements Approval Process………………………………………...…….b-38
c.7. Use of Securities Proceeds…………………………..……………………..b-40
c.8. Disclosure Regarding Consent to Perform Peer Review…………………..b-41
c.9. Negligible Transactions………………………………...………………….b-41
c.10. Connection Between Remuneration Given as per Regulation 21 and the Contribution of the Recipient to the Corporation…………………….……b-42
c.11. Audit Report – Securities Authority…………………….…………………b-44 d. Disclosure Provisions with Regard to Financial Reporting by the Corporation
d.1. Events Subsequent to the Balance Sheet Date………………..……………b-45
d.2. Critical Accounting Estimates…………..…………………………………b-45
d.3. Explanation of the Matter to which the Company's Independent Auditors Draw Attention in their Report on the Financial Statements…………...….b-45 e. Additional Information
e.1. Dividend Distribution Policy…………………..…………………………..b-46
e.2. Disclosure Regarding Changes in the Economic Environment, the Implications of the Capital Market Crisis and Market Risks………………b-46
Appendix - Assessment of the Total Value of the 777-200 and 747-400 Fleets..b-48
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El Al Israel Airlines Ltd. Report of the Board of Directors on the State of the Corporation's Affairs For the Year Ended December 31, 2010
We hereby present the Report of the Board of Directors on the State of the Corporation's Affairs for the year ending December 31, 2010.
2010 was a year of recovery in global aviation. The extraction from the global crisis continued, contributing (according to IATA data) to an 8.2% increase in global passenger traffic and a 20% increase in cargo traffic and brought about profitability in the aviation industry.
2010 saw a 9.5% increase in the number of passengers passing through BGN, which reached 11.4 million passengers compared to 10.5 million in 2009. Incoming passenger traffic increased by 16.4% compared to 2009 and departing Israeli traffic increased by 5.7%. The amount of cargo shipped by air increased from 272.4 thousand tons in 2009 to 300.0 thousand tons in 2010, a 10.1% increase.
In 2010 El Al listed a 10% increase in the number of passengers and scheduled and charter flights*, reaching 4.2 million passengers, and a 17.4% increase in airborne cargo, which amounted to 102.5 thousand tons in 2010. At the same time the Company maintained its 37.1% market share at BGN (37.5% in 2009) and a load factor of 81.6% (81.0% in 2009).
Group revenues in 2010 amounted to $1,972 million, a 19.1% increase over 2009. Gross earnings amounted to $387.7 million compared to $211.6 million the previous year, an 83.2% increase.
The Company listed a profit after tax of $57.1 million in the reported period compared to a $76.3 million loss in 2009.
Production of cash from current activity in 2010 amounted to a total of $203.3 million compared to $22.4 million in 2009.
The balance of the Group’s cash, cash equivalents and short-term deposits as of December 31 2010 totaled $174.6 million compared to $114.6 million on December 31 2009. The Company's equity as of December 31 2010 amounted to $247.5 million, a $123.7 million increase over December 31 2009.
In 2010 the Company management emphasized on its aircraft fleet equipping policy, its commercial policy and its protection from market risk policy.
In 2010 the Company continued with its response to increasing competition at BGN, which included the entry of new foreign airlines to BGN, added frequencies and the use of aircraft with larger capacities. In total, the capacity of other scheduled airlines at BGN increased by 10% in 2010. Over the past five years the seat availability of foreign airlines at BGN increased by 90%. The increase in capacity allowed these companies, which operated international hubs at their home airports, to increase the number of passengers flown between Israel and a large number of destinations via indirect flights, taking advantage of their route networks and that of their partners in global aviation alliances and code sharing agreements.
In August 2010, after receiving the permission of the Ministry of Transportation and Road Safety, the Company first began operating domestic flights on the BGN-Eilat route, and it currently transports 16% of the market on this route. In October 2010 the Company began operating a weekly flight to Hong Kong using its 747-400F cargo plane.
*A 7.5% increase in the number of passengers – without the Eilat flights.
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In the field of the Company's aircraft fleet the following actions were taken: in April 2010, following the global financial crisis and the changes in the aviation industry, the Company reached an understanding with Boeing to cancel its agreement to purchase wide-bodied aircrafts. The Company purchased and entered into service in February 2011 a 747-400 passenger aircraft, and in 2010 and as of the approval date of the Financial Statements, two leased passenger aircrafts, the first a 767-300 and the second a 737-800, and a 747-400 cargo plane. An additional leased 767-300 is expected to enter service in late March 2011. In addition, the Company extended lease agreements for five additional aircrafts. In February 2011 the Company signed an agreement with aircraft manufacturer Boeing (“the Agreement) for the purchase of four new Boeing 737-900 aircrafts and two additional aircraft of the same model convertible to purchase options. In addition, the Company was granted the option to purchase two additional aircraft of this model. The aircrafts are expected to join the Company’s aircraft fleet between late 2013 and 2016.
In 2010 the Company signed collaboration agreements with foreign airlines Air China, Siberia Airlines of Russia, Armavia Airlines of Armenia, Bulgaria Air, Aerosvit of Ukraine and Jet Blue. These agreements expanded the Company’s network of destinations and allow it to offer a variety of follow-up destinations on the routes which these airlines fly.
In 2010 the Company continued bringing in innovations and technological improvements to its operational systems, IT systems and in the field of environmental protection and customer service. Online collaboration was expanded, including travel insurance sales options as part of the reservation site and collaborations with leading sites. The Company has launched a new development allowing travel agents to see ticket details on their computer screens, print them out and send them by email. A designated iPhone app was launched for screening by Company executives in the Israeli station, and an existing app was purchased allowing customers to check out takeoff and landing times on their iPhones. A new flight planning system entered service in the Company’s control center. The system plans optimal flight routes and allows an extremely high level of precision.
On June 1 2010 the Company joined the BSP (Billing & Settlement Plan), the IATA clearing program, which was designed to make the sales, reporting and accounting process of airlines vs. travel agents simpler and more efficient. As part of the constant effort to improve service processes, a new system was placed at the entrance to the Company’s BGN lounge. Using the system, customers staying at the lounge are identified and personalized customer services can be offered. An information system for the management and tracking of air pollution from Company aircrafts was implemented in order to comply with EU guidelines.
In 2011 as well, the Company will continue with its efforts to position El Al as a leading Israeli and international brand while upgrading the quality of the product and service, formulating long-term and multi-dimensional strategic planning and investing in “people”.
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1. General
1.1 Changes in International Financial Standards (IFRS)
Starting from the first quarter of 2009, the Company has applied changes in accounting policy in its financial statements deriving from the application of new standards and interpretations of International Financial Reporting Standards (IFRS), which came into effect in 2009, including IFRS 8 "Operating Segments", IAS 1 (Revised) – "Presentation of Financial Statements", IFRIC 13 – "Customer Loyalty Plans" and the revision to IAS 19 – "Employee Benefits", in the framework of the IFRS improvements in 2008. For further details on the standards and the impact of their application to the Group's Financial Statements, see Note 3 to the December 31 2010 Financial Statements. Regarding the early adoption of International Accounting Standard IFRS 9, see Note 3a to the December 31 2010 Financial Statements.
1.2 The Company and its Business Environment
The Company serves as the designated air carrier of the State of Israel on most of the international routes operating to and from Israel.
The key activities of the Company and its subsidiaries are the transport of passengers and cargo by way of scheduled flights, and on the matter of the transport of passengers, also on charter flights between Israel and other countries and starting August 2010, on domestic flights as well. The Company is also engaged in providing security services and maintenance services, including for other airlines at Ben Gurion Airport, in the sale of duty-free products, in the leasing of aircraft, and through investees – in ancillary activities, mainly the manufacture and supply of airline food and the management of several overseas travel agencies.
The business environment in which the Company operates is the international and domestic civil aviation industry, and inbound and outbound tourism, which is characterized by a seasonal nature and strong competition, which grows stronger in periods of excess capacity, as well as high levels of sensitivity to the economic, political and security situation in Israel and around the world.
The Group has two operating segments reported as business sectors in the Company's consolidated Financial Statements: a) Passenger aircraft activity – In this segment, the Group transports passengers, as well as cargo in the cargo holds of passenger aircraft, and provides ancillary services, such as the sale of duty-free products and aircraft leasing. In the field of passenger transport, the Company competes with 2 Israeli airlines (Arkia and Israir) in its flights to and from Israel, with 59 foreign airlines that operate scheduled flights and with over 60 foreign charter airlines of which some 32 operate flights on a regular basis. The revenues of this segment constituted approximately 89.5% of the Group's total revenues in 2010. b) Cargo aircraft activity – In this segment, the Group transports cargo in cargo aircraft. In the field of cargo transport, the Company competes with an Israeli airline (CAL) and 6 foreign airlines operating cargo aircrafts on a regular basis, and with most of the scheduled airlines that operate
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passenger planes carry cargo in their cargo holds. The revenues from this area of activities represented approximately 4.4% of total Group revenues for 2010.
The Group has additional revenues that are not allocated to the major segments, accounting for 6.1% of their total revenues.
For further information on the Company's areas of activity, see Section A5 of the Report of the Board of Directors Report and Note 37 to the December 31 2010 Financial Statements.
1.3 Holdings of Company Shareholders
As of December 31, 2010, the holdings in the Company were:
K'nafaim Holdings Ltd. ("K'nafaim") – 39.3%, the Delek group – 7.4%, the Ginsburg Group – 8.7%, a Company employee corporation called "Holdings in Trust of El Al Employees Ltd." ("Employees Corporation") – 6.1%, others – 2.7%, the public – 35.8%.
Ratio of Holdings in Company Shares on December 31, 2010 (undiluted):
Knafaim Public 39.3% 35.8%
Delek Group Ginsburg 7.4% Group 8.7% Employees’ Trust Others Holdings 2.7% 6.1%
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Explanations of the Board of Directors for the State of the Corporation's Affairs
a.1 Financial Position (Consolidated Financial Statements)
31.12.2010 31.12.2009 change in thousands in thousands in thousands US dollars US dollars US dollars % Current assets Cash and cash equivalents 111,002 106,687 4,315 4% Short-term deposits 63,565 7,933 55,632 701% Restricted deposits - 7,003 (7,003) (100%) Trade receivables 132,960 112,086 20,874 19% Other receivables 20,880 16,155 4,725 29% Current derivative financial instruments 42,190 11,206 30,984 276% Prepaid expenses 26,995 20,395 6,600 32% Inventory 18,756 21,947 (3,191) (15%) Non-current assets Long-term bank deposits 1,869 1,839 30 2% Investment in affiliated companies 693 648 45 7% Investments in other companies 11,552 1,357 10,195 751% Derivative financial instruments 4,291 2,255 2,036 90% Fixed assets, net 1,231,687 1,312,930 (81,243) (6%) Intangible assets, net 7,844 7,504 340 5% Prepaid expenses 8,121 7,056 1,065 15% Assets due to employee benefits 38,799 34,501 4,298 12% Total Assets 1,721,204 1,671,502 49,702 3% Current liabilities Short-term borrowings and current maturities 147,587 106,016 41,571 39% Trade payables 157,912 128,970 28,942 22% Other payables 49,625 54,444 (4,819) (9%) Provisions 44,939 57,217 (12,278) (21%) Derivative financial instruments 2,329 55,643 (53,314) (96%) Employee benefit obligations 98,712 81,379 17,333 21% Unearned revenues 231,204 204,444 26,760 13% Non-current liabilities Loans from financial institutions 561,084 704,194 (143,110) (20%) Employee benefit obligations 65,590 65,835 (245) (0%) Derivative financial instruments 19,739 20,135 (396) (2%) Other payables 10,700 13,318 (2,618) (20%) Deferred tax 32,792 5,313 27,479 517% Long-term unearned revenues 51,467 50,813 654 1% Shareholders’ equity 247,524 123,781 123,743 100% Total liabilities and equity 1,721,204 1,671,502 49,702 3%
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The main changes in asset, liability and shareholders' equity items as of December 31 2010 compared to December 31 2009 are:
Current assets:
An increase in the balance of cash, cash equivalents and short-term deposits, due mainly to positive cash flow from operating activities, offset mainly by investment in fixed assets and regular repayment of loans. For further details, see Item 7a below.
The decrease in restricted deposits derives mainly as a result of the increase in fair value of jet fuel hedging transactions in the reported period.
The increase in trade receivables, derived mainly from the increase in passenger sales as well as cargo sales.
The increase in the balance of receivables mainly derives from debts of hedging institutions for jet fuel hedging transactions received by the Company in January 2011
The following changes occurred to the Company's derivative financial instruments (presented in the Financial Statements under current and non-current assets and current and non-current liabilities):
The total net change of the fair value of jet fuel, interest and foreign currency hedging was expressed in a $86.7 million increase compared to the fair value at the end of 2009, as a result of transactions reaching redemption, from additional transactions occurring in the reported period and from changes in the fair value of transactions still open as of the balance sheet date. The increase in fair value of derivative financial instruments was expressed in a $65.9 million increase (net after tax) in the capital reserve in respect of cash flow hedges recognized directly in equity, in the $21.4 increase in the deferred tax liability and offset by the $0.6 million net increase in fuel and financing expenses in the Statement of Operations. For further details regarding hedging transactions conducted by the Company see b.1.(3), b.1.(4) and b.1.(5) below.
The increase in the balance of prepaid expenses derives mainly from the increase in prepaid expenses for aircraft leases.
The decrease in inventories largely derived from the decrease in jet fuel reserves.
Non-current assets:
The increase in investment in other companies derives mainly from the Maman transaction, in which the Company received 7.5% of Maman’s issued and paid-up capital, as well as options exercisable as ordinary shares at a rate close to 10% of Maman’s share capital. For further details, see Note 39a to the Financial Statements .
Fixed assets decreased mainly due to depreciation costs and the consumption of parts and accessories in the reported period, offset by the investments made over the course of the year.
Assets due to employee benefits increased mainly as a result of listing the actuary losses due to compensation.
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Current liabilities:
Short-term credit balances and current maturities increased mainly as a result of the increase in current maturities of bank loans, mainly “balloon” loans, the repayment date of which is in April and August 2011, offset by the repayment of short-term bank borrowings. For further details see Note 22i to the Financial Statements.
Trade payable balances increase mainly as a result of the increase in activity, the increase in jet fuel prices and the revaluation of the NIS vs. the USD, which increased the NIS trade payable balance in dollar terms.
The balance of payables decreased mainly as a result of a decrease in deposits received for passenger groups.
The balance of provisions decreased mainly due to a settlement agreement pertaining to the income tax deduction assessments. See Note 28f to the Financial Statements. On the other hand, a provision was listed for a civil suit in the U.S. on the subject of cargo, see Note 27.c.b.(3) to the Financial Statements.
Employee benefit obligations increased mainly as a result of an increase in vacation and rest day obligations, salary bonus obligations and the revaluation of the NIS vs. the USD that increased the liability in dollar terms.
Unearned revenues increased mainly as a result of an increase in passenger sales.
Non-Current Liabilities:
The balance of loans from banking institutions decreased as a result of current repayment of loans and resorting loans to the current maturities item including a “balloon” loan from banking institutions the repayment date of which is in April and August 2011 (see Note 22i to the Financial Statements).
The decrease in other payables occurred mainly as a result of payment due to the U.S. cargo claim.
The increase in the deferred taxes item derives mainly from deferred tax expenses listed as a result of 2010 yearly profits and an increase in the fair value of hedging agreements recognized as defensive agreements.
Shareholders' Equity
The increase in the Company's shareholders' equity is primarily due to net profits for the year and the increase in the capital reserves due to cash flow hedging, as a result of the increase in the fair value of hedging agreements recognized as hedging, as a result of the payment of hedging agreements reaching conclusion as well as the positive fair value of hedging agreements carried out during the period.
As of December 31 2010, the Company has a working capital deficit of $316 million, compared with a deficit of $384.7 million on December 31, 2009. The Company’s current ratio as of December 31, 2010 amounted to 56.9% compared to 44.1% as of December 31, 2009. Among the main reasons for the decrease in the working capital deficit, one might note the increase in cash and short-term deposits as well as the increase in the fair value of derivative financial instruments. On the other hand, current maturities of bank loans and unearned revenues increased. The working capital deficit consists of three material elements included under the Company’s current liabilities items and characterized by current business cycles: unearned revenues from the sale of flight tickets including port taxes, unearned revenues from frequent flyer clubs, and employee vacation obligations. Therefore, a material part of the capital deficit is not cash flow- based and allows the Company to repay its short-term liabilities.
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a.2 Analysis of Operating Business Results of El Al
a.2.1 Market Data
Passenger and cargo Jan - Dec Jan - Dec change traffic at BGA 2010 2009 in thousands in thousands in thousands % Incoming tourists * 2,386 2,049 337 16% Departing Israelis * 3,591 3,397 194 6% Cargo import - tons ** 136 118 18 15% Cargo export - tons ** 164 154 10 7%
* Source: Central Bureau of Statistics. ** Does not include cargo in transit. Incoming Tourist & Departing Israeli Traffic, by Year (In Thousands):
3,591 3,433 3,552 3,397 4,000 3,145 3,000
2,386 2,000 2,190 2,049 1,790 1,565 1,000
0 2006 2007 2008 2009 2010 Incoming tourists Departing Israelis
Imports & Exports of Cargo by Air to and from Israel, by Year (in Thousands of Tons):
250 198.8 181.7 182.3 200 154.0 164.3 150
134.4 138.9 141.4 135.7 100 118.4 50
0 2006 2007 2008 2009 2010 Export Import
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a.2.2 Company Operating Data*
Jan - Dec Jan - Dec change 2010 2009 Passenger leg (scheduled and chartered) - in thousands 4,184 3,805 10% RPK (scheduled) - in millions 17,400 16,410 6% ASK (scheduled) - in millions 21,332 20,261 5% Load factor (scheduled) 81.6% 81.0% 1% The Company's market share (scheduled and chartered) 37.1% 37.5% (1%) Flown cargo, in thousand tons 102.5 87.3 17% RTK - in millions 542 440 23% Weighted flying hours (including leased equipment) - in thousands (*) 166.0 157.4 5% Average man-years (El AL only): Permanent 3,820 3,772 1% Temporary 2,091 2,075 1% Total 5,911 5,847 1%
Aircraft in operation - end of period - number of units 39 38 1 Average age of owned fleet at the end of the period - in years 13.2 13.1 0.2
* Operating data refers both to international and domestic activity.
* Total employees (permanent and temporary) in job slots – as of December 31, 2010: 5,964 and as of December 31, 2009: 5,781.
Glossary: Passenger leg – Flight coupon in one direction. RPK – Revenue Passenger Kilometer – number of paying passengers multiplied by distance flown. ASK – Available Seat Kilometer – number of seats offered for sale multiplied by distance flown. RTK – Revenue Ton Kilometer – weight of paid flown cargo in tons multiplied by distance flown. Passenger Load Factor (occupancy) – flown passenger-km is expressed as a percentage of available seat- km.
* Weighted flight hours in Boeing 767/757 terms. Weighted value of the planes: Boeing 767/757 = 1.0; Boeing 747 = 2.0; Boeing 777 = 1.6; Boeing 737 = 0.6. These weighted values were determined based on an estimate of the total expenses of each type of aircraft, and are used consistently to calculate weighted flight hours as an indicator of the volume of aviation activity.
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Operating Data, by Year (in Millions):
25,000 100% 21,332 19,750 20,104 20,074 20,261 20,000 17,068 17,400 90% 16,055 16,529 16,410 15,000 84.9% 80% 82.3% 10,000 81.3% 81.0% 81.6%
5,000 70% 2006 2007 2008 2009 2010 RPK ASK L. F.
a.3 Statement of Operations Data For the Year Ending December 31, 2010 (Consolidated Financial Statements):
Jan - Dec Jan - Dec change 2010 2009 in % of in % of in thousands operating thousands operating thousands US dollars revenues US dollars revenues US dollars % Operating revenues 1,972,239 100% 1,655,833 100% 316,406 19% Operating expenses (1,584,557) (80.3%) (1,444,250) (87.2%) (140,307) 10% Gross profit 387,682 19.7% 211,583 12.8% 176,099 83% Selling expenses (214,755) (10.9%) (182,962) (11.0%) (31,793) 17% General and administrative expenses (96,153) (4.9%) (88,562) (5.3%) (7,591) 9% Other operating revenues (expenses), net 11,269 0.6% (15,027) (0.9%) 26,296 Operating profit (loss) before financing 88,043 4.5% (74,968) (4.5%) 163,011 Financing expenses (35,911) (1.8%) (30,297) (1.8%) (5,614) 19% Financing income 10,849 0.6% 3,999 0.2% 6,850 171% Company's equity in earnings of affiliates, net 45.00 0.0% 442 0.0% (397) (90%) Profit (loss) before income taxes 63,026 3.2% (100,824) (6.1%) 163,850 Tax benefit (income taxes) (5,971) (0.3%) 24,524 1.5% (30,495) Profit (loss) for the period 57,055 2.9% (76,300) (4.6%) 133,355
The key factors that influenced the business results in the year ending December 31, 2010 compared with last year:
The recovery of the global economy and the stabilization of the security situation in our region were expressed in the Company's operating data as detailed in a.2.2. above. The Group transported 4.2 million passengers in scheduled and charter flights and transported 102.5 thousand tons of cargo, a 10.0% and 17.4% increase, respectively, over 2009. The load factor in passenger flights reacted 81.6% (81.0% in 2009). Net income per passenger-kilometer increased by 11.5% and income per ton-kilometer increased by 11.3% compared to 2009. This data led to improvements in the Company’s operating results, despite the 15% increase in effective jet fuel prices and the 5% revaluation of the average rate of the NIS relative to the USD which increased Company expenses.
Operating revenues – operating revenues increased 19.1% over 2009. Passenger revenues increased both as a result of the increase in passenger traffic and the increase in yield per passenger kilometer. Cargo shipping
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revenues also increased, mainly as a result of the increase in cargo traffic and the increase in yield per ton kilometer.
Operating expenses – 2010 saw a 9.7% increase in the Company's operating expenses compared to 2009, mainly as a result of the increase in jet fuel expenses and salary expenses as detailed below, as well as from the from the increase in expenses due to aircraft leases. At the same time, the share of operating expenses from turnover decreased from 87.2% in the 2009 to 80.3% in 2010. Note that over the course of 2010, the Company listed receipts to the amount of $4.3 million for operational discounts received pursuant to the Maman transaction, and an additional $11.1 million for the allocation of 7.5% of Maman’s share capital and 10% of its options for the purchase of Maman’s shares. These sums reduced the Airport Fees and Services item under Operating expenses in the Company’s Statement of Operations. (See Note 39a to the Financial Statements).
• The increase in the Company's salary expenses in 2010 compared to 2009 derives mainly from the revaluation in the rate of the NIS vs. the USD, from the salary bonus provision and the increase in activity. Regarding the impact of the changes in the NIS/USD rate of exchange on the Company’s employee benefit obligations, see a.4 below.
• The Company's jet fuel expenses increased mainly as a result of the increase in jet fuel prices in 2010 relative to the 2009 and as a result of the increase in activity. The market prices for jet fuel in the Med region increased by an average of 28% compared to 2009, while the Company's effective price after hedging activity increased by 14.9%. Over the course of 2010 the Company made jet fuel hedging payments to the amount of $49.9 million ($103.3 million in 2009), which were charged to gain/loss. The change in the fair value of transactions charged to gain/loss reduced jet fuel expenses by $0.8 million ($21.9 million in 2009).
For further information on jet fuel price hedging see b.1.(3) below.
Gross profit amounted to $387.7 million in 2010, 19.7% of turnover compared to $211.6 million, 12.8% of the 2009 turnover.
Breakdown of Operating Expenses in 2010:
Jet fuel Meals Depreciation lease 37% 3% 7% expenses 4%
Airport fees & security service expenses 10% 2% Other expenses Air crew 3% expenses 3% Maintenance Wages and Air navigation of aircraft social benefits & 6% 19% communication 6%
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Sales expenses – sales expenses increased compared to 2009, mainly as a result of the increase in distribution expenses and from orders made in the global distribution systems (GDS) as a result of the increase in activity. The total rate of sales expenses from turnover amounted to 10.9% relative to 11.0% of turnover in 2009.
General and administrative expenses – administrative and general expenses increased relative to 2009, primarily due to the increase in salary expenses as noted above, but at the same time their share of the Company's turnover reached 4.9% compared to 5.3% in 2009.
Other revenues and expenses – over the course of 2010 the Company listed other net expenses to the amount of $11.3 million, mainly as a result of the partial cancellation of a provision for income tax- deductions, following the settlement signed with the Income Tax Commissioner in February 2011 regarding free and discounted flight tickets for Company employees as well as additional items under dispute. For further details, see Note 28f to the Financial Statements. In addition, an expense was listed in 2010 pertaining to early retirement plans resulting from a new plan for the retirement of 11 employees and from the change in the dollar value of liabilities as a result of the revaluation of the NIS relative to the USD. In addition, the settlement for the U.S. cargo claim was also noted, see Note 27.c.b.(3) to the Financial Statements, and expenses was also listed pertaining to the fine placed on the Company by the Securities Authority, see Note 42.8. to the Financial Statements. In 2009 the Company listed other expenses to the amount of $15.0 million mainly as a result of listing the impairment of aircraft and engines and intangible assets.
Operational profit for 2010 amounted to $88.0 million, 4.5% of turnover, compared to an operational loss of $75.0 million in 2009.
Financing expenses – the increase in financing expenses in 2010 compared to 2009 derives mainly from exchange rate differentials due to the revaluation of the NIS relative to the USD, offset by a decrease in bank commissions.
Financing income - an increase occurred in the Company's financing income deriving mainly from receipts due to NIS/USD hedging agreements.
Pre-tax profit for 2010 amounted to $63.0 million compared to a pre-tax loss of $100.8 million in 2009.
Net profit amounted to $57.1 million, 2.9% of turnover, compared to a loss of $76.3 million, and 4.6% of turnover in 2009.
Oct - Dec Oct - Dec change 2010 2009 in % of in % of in thousands operating thousands operating thousands US dollars revenues US dollars revenues US dollars % Operating revenues 492,016 100% 413,675 100% 78,341 19% Operating expenses (393,847) (80.0%) (362,555) (87.6%) (31,292) 9% Gross profit 98,169 20.0% 51,120 12.4% 47,049 92% Selling expenses (65,198) (13.3%) (44,585) (10.8%) (20,613) 46% General and administrative expenses (26,343) (5.4%) (24,294) (5.9%) (2,049) 8% Other operating revenues (expenses), net 15,490 3.1% (14,041) (3.4%) 29,531 Operating profit (loss) before financing 22,118 4.5% (31,800) (7.7%) 53,918 Financing expenses (8,072) (1.6%) (6,018) (1.5%) (2,054) 34% Financing income 3,963 0.8% 2,703 0.7% 1,260 47% Company's equity in earnings of affiliates, net 45 0.0% 361 0.1% (316) (88%) Profit (loss) before income taxes 18,054 3.7% (34,754) (8.4%) 52,808 Tax benefit (income taxes) (1,771) (0.4%) 5,734 1.4% (7,505) Profit (loss) for the period 16,283 3.3% (29,020) (7.0%) 45,303
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Key factors that influenced the business results in the three-month period ending December 31, 2010 compared with the same period last year:
Operating revenues – operating revenues in Q4 2010 increased by 18.9% compared to 2009 and amounted to a total of $492.0 million. The increase derived also from passenger revenues and also from cargo revenues, as a result of an increase in the number of passengers and the amounts of cargo and an increase in RPK and RTK.
Operating expenses – increased by 8.6% in the reported quarter compared to the same quarter last year, mainly as a result of the increase in jet fuel expenses, both as a result of the increase in market prices and as a result of the increase in activity. Salary costs increased mainly from the increase in activity, from the provision to salary bonuses as well as from revaluation of the NIS relative to the USD in the reported quarter versus the same period last year. Note that in the reported quarter, the Company listed receipts to the amount of $0.6 million for operational discounts received pursuant to the Maman transaction, and an additional $8.4 million for the allocation of 3.75% of Maman’s share capital and 10% of its options for the purchase of Maman’s shares. These sums reduced the Airport Fees and Services item under Operating expenses in the Company’s Statement of Operations. (See Note 39a to the Financial Statements ).
Gross profits in the reported quarter amounted to $98.2 million, 20.0% of turnover compared to a gross profit of $51.1 million, and 12.4% of turnover, in the same quarter last year.
Sales expenses increased compared to the same quarter last year, mainly as a result of an increase in advertising expenses as well as sorting between passenger discount items and agent commission items. This action does not influence the quarter’s financial results.
General and administrative expenses increase by 8.4%, mainly as a result of the increase in salary expenses as noted above, but at the same time their share of turnover decreased from 5.9% in Q4 2009 to 5.4% in the reported period.
Other operating revenues – amounted to $15.5 million in Q4 2010, as a result of the settlement signed with the Income Tax Commissioner in February 2011 regarding free and discounted flight tickets for Company employees as well as additional items under dispute. For further details, see Note 28f to the Financial Statements. In addition, an expense was listed in Q4 2010 pertaining to early retirement plans resulting from a new plan for the retirement of 11 employees. Furthermore, a provision for the U.S. cargo claim was also listed, see Note b27.c.b.(3) to the Financial Statements, and a provision was also listed pertaining to the fine placed on the Company by the Securities Authority, see Note 42. 8. to the Financial Statements. In Q4 2009 the Company listed other expenses to the amount of $14.0 million mainly as a result of listing the impairment of aircraft and engines and intangible assets.
The Company listed an operational profit before financing in Q4 2010 to the amount of $22.1 million, 4.5% of turnover compared to a $31.8 million operational loss, and 7.7% of turnover in the same quarter last year.
Financing expenses increased, mainly due to exchange rate differences as a result of the revaluation of the NIS vs. the USD.
Financing income increased, mainly from receipts due to NIS/USD hedging agreements.
In total, in the fourth quarter of 2010 the Company listed a net profit of $16.3 million compared to a loss of $29.0 million in the same period last year.
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a.4 Effect of Changes in the Exchange Rate on the Company's Accrued Severance Pay Liability
In 2010 the exchange rate of the shekel appreciated against the dollar by 6.0%, compared with appreciation in the exchange rate of the shekel against the dollar of 0.7% in 2009.
In the three month period ending December 31 2010 the exchange rate of the shekel increased against the dollar by 3.2%, compared with a 0.5% depreciation in the exchange rate of the shekel against the dollar of the same quarter last year.
US Dollar - NIS Exchange Rate:
4.5 4.188 4.2 3.919 3.875 3.802 3.758 3.775 3.9 3.713 3.665 3.549 3.6
3.3
3.0 31.12.08 31.03.09 30.06.09 30.09.09 31.12.09 31.03.10 30.06.10 31.12.10 30.9.10
The Company has obligations to its employees for severance pay, retirement plans, sick pay, and vacation pay as of December 31 2010 to the amount of $81 million. Since most of these obligations are denominated in shekels, whereas the functional currency of the Company is the dollar, these obligations must be translated into dollars, which causes differences deriving from changes in the exchange rate of the shekel against the dollar. Exchange rate changes are not one-directional, and cause the listing of revenues or expenses in the Company's Financial Statements. These revenues or expenses do not impact cash flow or operating costs of the Company in the short run. In order to enable a comparison of the Company's business results for the long run, these revenues or expenses should be neutralized.
Expenses for this element to the amount of $4.5 million were listed in 2010, compared to 2009, in which the expenses for this element decreased by $0.3 million.
In the quarter ending December 31 2010, expenses were listed due to this component to the amount of $2.0 million, compared to the same quarter last year, during which expenses for this component decreased by $0.3 million.
Presented below are details of the business results, after neutralizing the effect of the exchange rate on the accrued severance pay element, as described above:
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Before After neutralizing the exchange-rate effect For year ended on the accrued severance pay 31 December: 2010 2009 2010 2009 (in thousands US dollars) Operating expenses 1,584,557 1,444,250 1,581,678 1,444,222 Gross profit 387,682 211,583 390,561 211,611 Gross profit rate 19.7% 12.8% 19.8% 12.8% Selling, general and administrative expenses 310,908 271,524 310,518 271,616 Other operating income (expenses), net 11,269 (15,027) 12,499 (15,265) Operating profits (loss) before financing expenses 88,043 (74,968) 92,542 (75,270) Operating profits (loss) rate before financing 4.5% (4.5%) 4.7% (4.5%) Loss for the period 57,055 (76,300) 61,554 (76,602) Loss for the period rate 2.9% (4.6%) 3.1% (4.6%)
a.5 Segment Reporting
Presented below is operational segment data on a consolidated basis: a. General:
The Group has applied IFRS 8, "Operating Segments" (hereinafter "IFRS 8") starting January 1 2009.
According to IFRS 8, operational segments are identified based on internal reports on the Group's components, which are reviewed on a regular basis by the Group's chief operating decision maker for the purpose of allocating resources and assessing the performance of the operational segments.
The report array conveyed to the Group's chief operating decision maker, for the purpose of allocating resources and assessing the performance of the operational segments based on the difference between revenues from passenger aircraft, cargo aircraft, charter flights (mainly to subsidiary Sun D'Or) and other revenues. In light of the above, the following are the Company's reported operating segments in accordance with IFRS 8:
Segment A – passenger aircraft activity.
Segment B – cargo aircraft activity.
In the 2009, Company Management has decided that in determining the results of the reported operating segments, a number of components not part of the direct costs involved in operating the flights, which have been included to date under "unattributed costs", such as depreciation as a result of aviation equipment, fixed maintenance costs and fixed costs at overseas offices must also be allocated.
Operating segment results for 2010 as well as comparison figures in this report are presented according to the format set as noted above.
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b. Analysis of income and results by operating segment:
For year ended: passenger cargo others Adjustment Total 31.12.2010 aircraft aircraft consolidated in thousands US dollars operating revenues revenue from external customers 1,765,282 87,508 38,790 80,659 1,972,239 inter-segment revenues - - 78,573 (78,573) - Total segment revenues 1,765,282 87,508 117,363 2,086 1,972,239
se gm e nt re sults 251,825 (264) 28,573 280,134 Unassigned expenses (192,091) Operating profit before financing 88,043 Financing expenses (35,911) Financing income 10,849 Company's equity in earnings of affiliates, net 45 Profit before income taxes 63,026 Income taxes (5,971) Profit for the period 57,055
For year ended: passenger cargo others Adjustment Total 31.12.2009 aircraft aircraft consolidated in thousands US dollars operating revenues revenue from external customers 1,489,496 58,317 37,874 70,146 1,655,833 inter-segment revenues - - 68,051 (68,051) - Total segment revenues 1,489,496 58,317 105,925 2,095 1,655,833
se gm e nt re sults 112,453 (27,457) 27,457 112,453 Unassigned expenses (187,421) Operating loss before financing (74,968) Financing expenses (30,297) Financing income 3,999 Company's equity in earnings of affiliates, net 442 Loss before income taxes (100,824) Tax benefit 24,524 Loss for the period (76,300)
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For year ended: passenger cargo others Adjustment Total 31.12.2008 aircraft aircraft consolidated in thousands US dollars operating revenues revenue from external customers 1,832,126 139,474 50,935 73,791 2,096,326 inter-segment revenues - - 76,350 (76,350) - Total segment revenues 1,832,126 139,474 127,285 (2,559) 2,096,326
se gme nt re sults 218,981 (19,305) 44,453 244,129 Unassigned expenses (249,783) Operating loss before financing (5,654) Financing expenses (61,566) Financing income 16,969 Company's equity in earnings of affiliates, net 543 Loss before income taxes (49,708) Tax benefit 7,801 Loss for the year (41,907)
The improvement in the Company's business results in 2010 compared to 2009 as explained in Section a.3 above was expressed in all areas of activity, both in the increase in revenues and the increase in the contribution of all the segments. The results of the passenger airplane segment improved by 124%, while the cargo aircraft segment, which listed a loss in 2009, mainly as a result of the global financial slump, saw a 99% improvement and is close to breaking even. A 4% improvement was also listed in the results of the Company's other activities. c. Analysis of revenues by destination:
America Europe Central Asia Rest of Total & Far East the world in thousands US dollars Year 2010 Operating revenues 673,030 905,582 299,468 50,268 1,928,348 Non-segment revenues 43,891 Total consolidated revenues 1,972,239
Year 2009 Operating revenues 547,639 797,327 230,468 38,334 1,613,768 Non-segment revenues 42,065 Total consolidated revenues 1,655,833
Year 2008 Operating revenues 712,029 995,984 296,591 46,650 2,051,254 Non-segment revenues 45,072 Total consolidated revenues 2,096,326
2010 saw an increase in revenues from all destinations compared to 2009.
"American" destinations saw a 23% increase in revenues, flights to and from Europe saw a 14% increase in revenues, flights to Central and East Asia saw a 30% increase and "the rest of the world" saw a 31 % increase relative to 2009.
As noted above, most of the increase in revenues derived mainly from the increase in passenger number and cargo amounts and from the increase in yields per passenger kilometer and cargo ton kilometer.
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a.6 Seasonal Factors The Group's activity is seasonal and focuses on peak periods. High traffic of Israeli residents abroad occurs principally in the summer seasons and at holiday times, and the greatest traffic of tourists to Israel is principally in the summer season or approaching the Jewish or Christian holidays or vacation time in their countries of origin. The peak of the Group's activity is in the third quarter, when passenger traffic in 2010, 2009, and 2008 constituted 28%, 30%, and 29% respectively of total yearly revenues.
Revenue breakdown by quarters and percentage of turnover in 2010 (in millions of dollars):
600 561.2 50% 498.5 492.0 500 420.5 40% 400 300 30% 200 28.5% 25.3% 24.9% 20% 100 21.3% 0 10% Q1‐10 Q2‐10 Q3‐10 Q4‐10 revenues % of revenues
a.7 Liquidity and Financing Sources
Jan - Dec Jan - Dec change 2010 2009 in thousands in thousands in thousands US dollars US dollars US dollars Cash flows from operating activities 203,291 22,399 180,892 Cash flows used for investing activities (95,232) (9,626) (85,606) Cash flows from (used for) financing activities (103,744) 43,314 (147,058) Net increase in cash and cash equivalents 4,315 56,087 (51,772)
Operating Activities
The increase in cash flows from operating activities in 2010 compared to the previous year, derives mainly from the $164 million increase in pre-tax profits, from a decrease in non-cash flow expenses as a result of changes in the fair value of financial assets and liabilities by way of gain/loss to the amount of $24 million, and from an increase in net liabilities in asset and liability items to the amount of $33 million. At the same time, depreciation and amortization expenses decreased by 30 million in the reported period and profits from Maman shares and options received not in return for cash to the amount of $11 million were also listed.
Investment Activities
In 2010 the Company used $46.5 million for investments in fixed assets and general engine repairs, and $55.6 million for investments in short-term deposits and $3.1 million for investments in intangible assets. On the other hand, the Company received $7.0 million from the realization of restricted deposits and $2.8 million from the realization of fixed assets. In total, the Company used $95.2 million for investment activity in 2010.
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In 2009, the Company invested $178.7 million in fixed and intangible assets and in engine overhauls ($126.0 million of which was for the purchase of new aircraft), and the Company saw $146.0 million from the realization of restricted deposits and a $22.8 million yield from the realization of fixed assets. Overall, the Company used $9.6 million for investment activities in 2009.
Financing Activities
In 2010, the Company repaid loans to the amount of $79.4 million, as well as repaid short-term credit from banking institutions to the amount of $26.9 million. On the other hand, in 2010 the Company received long- term loans to the amount of $2.6 million. In total, $103.7 million were used for financing activity in 2010.
In 2009 the Company received loans to finance the purchase of three new Boeing 737-800 planes to the amount of $113.3 million, as well as an increase in short term credit from banking institutions amounting to $12.1 million. The Company repaid loans and paid loan raising expenses to the amount of $82.0 million. In total the Company received $43.3 million from financing activity in 2009.
The Group’s total cash and cash equivalents and short-term investments as of December 31, 2010 totaled $174.6 million, compared to $114.6 million as of December 31 2009. As of December 31 2010 the Company had no restricted deposits for jet fuel hedgers, compared to $7.0 million in restricted deposits on December 31 2009.
The average scope of Company bank loans over the course of 2010 amounted to $752 million ($786 million in 2009).
The average amount of trade payables received by the Company during 2010 was $148 million ($139 million in 2009).
The average amount of credit given by the Company to its receivables during 2010 was $153 million ($128 million in 2009).
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b. Market Risk Exposure and Management:
b.1 Qualitative Reporting on Exposure to and Management of Market Risks
b.1. (1) General – Description of Market risks to which the Company is Exposed
Presented below is a summary of the market risks to which the Company is exposed:
Changes in prices of jet fuel, which constitutes a significant element of the Company's operating expenses, have a material effect on the Company's profitability. In the Company's estimation, at its current level of activity, every change of $0.01 in the price of a gallon of jet fuel during an entire year influences the Company's fuel expenses by $2.5 million. The Company has taken hedging measures to reduce the exposure, as detailed in b.1.(3) below.
Changes in jet fuel may influence the scope of securities the Company may be required to deposit with jet fuel hedgers.
Exposure to changes in interest rates – most of the Company's long-term loans are at variable interest. Therefore, an increase in the LIBOR rate could impact the Company's profitability. At the present level of activity, every 1% increase in the Libor rate for a full year increases the Company's financing expenses by $6.2 million. The Company has adopted hedging measures to reduce the exposure, as provided in Section b.1.(4) below.
Currency exposure – Most of the Company's revenues and expenses are in foreign currency (mainly the U.S. dollar), except for several shekel expenses, mainly salary expenses and payments to local suppliers in Israel. Accordingly, a change in the shekel/dollar exchange rate influences the Company's shekel expenses in dollar terms. In the Company's estimation, at the present level of activity, appreciation of the exchange rate of the shekel relative to the dollar by each 1% for an entire year increases the Company's annual expenses by $3.5 million. Likewise, a surplus of payments over receipts exists in euros, but at insignificant rates.
The Company has adopted hedging measures to reduce the exposure, as provided in Section b.1.(5) below.
Exposure in long-term loan frameworks – according to the provisions of the loan agreements, the Company must maintain a minimal collateral ratio between the market value of the planes and the balance of the loans that financed their purchase. Likewise, the Company is required to comply with certain covenants, which, if not complied with, can be used to compel the Company to immediately repay the loans. The Company's exposure to market risks in this area derives from the changes that occur in the market value of planes around the world, due to exceptional security events, and to the excess supply of seats on airlines around the world. For further details, see Note 16.g. and Note 22.g.1. to the December 31 2010 Financial Statements.
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b.1.(2) El Al Market Risk Management Policies, Officials Responsible for their Management and Means of Controlling and Executing Policy
The Company has a Board of Directors Committee for market risks management, headed by Mr. Nadav Palti, which is responsible for determining coverage policies for existing exposures. The CFO is responsible for executing the policy and reporting to the Market Risks Management Committee.
From time to time, the Market Risk Management Committee evaluates the Company's status in the area of jet fuel, interest and exchange rate exposure, the need to invest in derivatives, to reduce the exposure in accordance with policy, as well as the financial instruments used to perform the required hedging.
The Company's policy as regards jet fuel hedging in 2010 was: hedging jet fuel quantities for up to 24 months forward, so that for every period, a minimum and maximum percentage to be hedged out of total expected consumption decreases gradually. Accordingly, the maximum hedge percentage at the beginning of the period is 80% and the minimum percentage at the end of the period is 20%.
Subsequent to the balance sheet date, the jet fuel hedging policy was altered as follows: hedging jet fuel quantities for up to 24 months forward, so that for every period, a minimum and maximum percentage to be hedged out of total expected consumption, in a gradually decreasing manner. Hedging agreements shall be carried out on a monthly basis. The maximum hedging rate at the beginning of the period is 75% and the minimum hedging rate for the 12th month is 5%. Instruments and hedging levels shall be selected so that the Company limits its maximum exposure to cash securities. For further details see Note 31.g to the Financial Statements.
The Company's policy with respect to interest hedging is to hedge half of the credit portfolio for a period of up to 5 years. As of this report, the Company is hedged according to its policy. For further details see Note 31.f to the Financial Statements.
The Company's policy with respect to NIS/USD exchange rate hedging in 2010 is to hedge up to half of its NIS exposure for one year forward. Subsequent to the balance sheet date the NIS/USD exchange rate hedging policy was changed to hedge up to 75% of its cash flow exposure for a 1-year outlook, as decided by the management. For further details, see Note 31.e to the Financial Statements .
From time to time the Market Risk Management Committee instructs Company Management to exceed these rates set for jet fuel, interest and exchange rates for limited periods of time in accordance with market developments.
For details on the policy adopted, see Sections b.1.(3), b.1.(4) and b.1.(5) below. For details regarding the influence of the changes in the economic environment, the implications of the crisis in capital markets and market risks after the balance sheet date see Section e.2 below.
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b.1 (3)Hedging Jet Fuel Prices
The Company executes financial transactions to hedge against changes in jet fuel prices, in accordance with its policy as described in Section b.1.(2) above.
As of December 31, 2010, the Company entered into several agreements to hedge jet fuel prices, at 33% of the expected consumption for 2011 and 5% of the consumption expected for 2012. These transactions are recognized as hedging agreements for accounting purposes. The fair value of all jet fuel hedging instruments as of December 31, 2010 is $34.3 million, presented in the Financial Statements as part of current and non- current assets under "Derivative Financial Instruments". In 2010 the Company paid a total of $49. 9 million for these hedging agreements in 2010. For additional details on these transactions, see Note 31.f to the December 31, 2010 Financial Statements. For details regarding the jet fuel instrument swap carried out by the Company in March 2010, see Note 42.10. to the Financial Statements.
For details regarding changes in jet fuel prices subsequent to the balance sheet date, see Section e.2.(b) of the Board of Directors report.
b.1. (4) Hedging Interest on Loans
The Company executes hedges of the exposure in its long-term credit portfolio, due to changes in interest rates, in accordance with its policy as laid out in Section b.1.(2) above.
Some of these financial instruments are recognized for accounting purposes as hedge transactions and some are not. The fair value of these instruments as of December 31, 2010 is a negative sum of $22.1 million, which is presented in the Financial Statements within the framework of current liabilities and non-current liabilities under "Derivative Financial Instruments”.
After executing these hedges, as of December 31, 2010, 39% of the balance of the Company's loans is at fixed interest rates for a two year period. In addition, the Company has, as of December 31, 2010, a balance of loans to the amount of $99.1 million at fixed interest for a period of 10 years constituting 14% of all of the Company's loans.
The Company paid refunds for these hedging agreements to the amount of $10.5 million over the course of 2010.
For additional information on these transactions, see Note 31.f to the December 31, 2010 Financial Statements.
For information on changes in interest rates occurring subsequent to the balance sheet date, see Section e.2.(c) of the Board of Directors Report below.
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b.1. (5) Exchange Rate Hedges
The Company executes hedges to protect its currency exposure due to changes in the exchange rate of the NIS versus the USD, in accordance with its policy as laid out in Section b.1.(2) above.
In August 2010 the Company entered into a number of financial transactions intended to protect the Company from drops in the exchange rate of the USD vs. the NIS for a 13 month period starting December 2010. These transactions are recognized as hedges for accounting purposes.
Subsequent to the balance sheet date, in February 2011, the Company entered into additional financial transactions intended to protect the Company from drops in the exchange rate of the USD vs. the NIS for a period of 13 months ending February 2012. These transactions are recognized as hedges for accounting purposes.
The fair value of these instruments as of December 31, 2010 is $12.2 million, presented in the Financial Statements as part of current and non-current assets under "Derivative Financial Instruments".
The Company received refunds for exchange rate hedging agreements to the amount of $7.9 million over the course of 2010.
For additional information on these transactions, see Note 31.e. to the December 31, 2010 Financial Statements.
For information on changes in the NIS-USD exchange rate occurring subsequent to the balance sheet date, see e.2.(d) below.
b.1. (6) Sensitivity Analysis Reporting
Presented below is a sensitivity analysis of the fair value of the financial instruments sensitive to possible changes in the risk factors to which they are exposed.
The sensitivity analyses were performed relative to the fair value of the financial instruments as of December 31, 2010.
The following is a description of the models for examining the fair value sensitivity of the various financial instruments:
1. Interest hedge – Interest hedges are executed by means of financial instruments opposite Israeli banks. The underlying asset for these transactions is the Libor (London Inter Bank Offered Rate) rate as published on the "Reuters" screens for various periods (3 months, 6 months, one year), whereby the interest return on the Company's variable-interest loans (plus a margin) is established.
Interest hedges are executed "back to back", in order to not create additional exposure of timing differences between the expiration date of the transaction and actual payment against the existing loans, so that the settlement dates match the repayment dates of the loans. On the loan repayment dates, the settlement amount
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is calculated for the next period, according to the market interest that prevailed on the two prior business days, and based on the structure of the transactions as determined in advance.
Existing interest hedges include options and fixing interest rates (IRS).
The fair value of interest hedges is calculated according to the projected Libor rate. In interest hedges in which the interest rate is fixed, the fair value is determined based on the difference between the projected interest and the interest published periodically by the world's leading banks, for the interest stated in the transaction, multiplied by the size of the hedge in each period. In hedge transactions that include options, the fair value is determined based on mathematical formulas for pricing options in recognized models.
2. Exchange rate hedge – Exchange rate hedges carried out by the Company are executed using financial instruments in conjunction with banks in Israel, similar to interest hedges.
The underlying asset for these transactions is the representative exchange rate for USD/NIS currencies determined by the Bank of Israel. USD/NIS exchange rate hedges are executed in order to hedge the cash flow exposure to the NIS as detailed in b.1.(5) above.
Yearly exposure scope is $350 million. The transactions for hedging this exposure according to the Company's policy are monthly, corresponding with the conversion dates of USD to NIS for the purpose of paying salaries and suppliers in Israel.
The transactions conducted by the Company in 2010 are forward transactions, with the Company receives a refund if the exchange rate on the determining date is below the transaction rate and pays if the exchange rate exceeds the transaction rate on the determining date.
These transactions are recognized as hedges for accounting purposes. The fair value of these transactions is calculated based on mathematical formulas for pricing options in recognized models.
3. Jet fuel hedges – Jet fuel constitutes the most material component of Company expenses
Jet fuel hedge transactions are carried out by the Company using financial instruments in conjunction with the leading Israeli and global financial institutions and banks engaged in this market.
The underlying asset in these transactions is jet fuel in the various markets that serve as the basis for determining the jet fuel prices that the Company actually pays, and mainly Jet Aviation FOB Med. In addition to this market, the Company purchases jet fuel according to its price in other markets, of which the key ones are Singapore, US Gulf Coast and North West Europe.
Jet fuel is an essential raw material for the Company for its operations – the Company is obligated to purchase the raw material in order to fly its aircrafts, and there is no substitute or ability to maneuver between the costs of these raw materials and other raw materials. The price of jet fuel is very volatile.
The market price of jet fuel is determined based on several parameters, including:
Crude oil prices include market expectations and supply and demand. The pace of demand for oil and it products has risen in recent years, due to the global growth (especially the growth rate in China). The supply of oil and its products is limited by physical and infrastructure factors (oil reserves, production infrastructures, refining, storage, transport, etc.), and by geopolitical and cartel influences of the large oil producers (OPEC). The marginal cost for fuel production is different at various levels of production, increasing along with the required level of production (as an example, the cost of producing a barrel of oil via deep sea drilling is three or four times the cost of producing a barrel of oil from Arabian oil wells). At the end of 2008 and in the first half of 2009, as a result of the global financial crisis, a drop occurred in
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predicted future demand for petroleum products. In the final months of 2009 and over the course of 2010 we've observed increased demand and renewed price increases.
Price fluctuations – Due to the meeting of the limited supply and the surging demand in recent years, any change, or expectations for change, in one of these factors, causes strong price fluctuations (such as: levels of economic activity and global growth, wars and terrorism, shut-downs and problems at large oil refineries, international relations and more).
The following graph shows the fluctuations in WTI crude oil prices over recent years:
WTI Crude Oil Price ($/Barrel)
Prices are in USD per barrel of crude oil.
Seasonal demand for various crude distillates, including jet fuel (In the winter there is high demand for heating oil; in the summer there is high demand for gasoline. Likewise, transport costs vary, conforming to seasonal risks in sea shipping).
Production cost and infrastructure limitation – Distillate prices vary according to various constraints of the oil refining industry, refining infrastructures, storage and transport of oil and its products are limited, cost of their development is very high and their expansion takes many years (construction of a refinery takes 5-7 years).
Moreover, future prices for oil and its derivatives (including jet fuel) are also strongly affected by the strength of the financial demands of institutional investors and speculators, which include these products in their investment portfolios.
In recent years, due to various reasons (including those mentioned above), the risk embedded in the markets and the price fluctuations are very high. In recent quotes received by the Company, a very high standard deviation was derived.
In view of the behavior of the markets, investment houses and the world's leading analysts are having difficulty in precisely and consistently estimating the price-change trends.
The forecasting ability of the various investment houses and analysts represent, at most, the immediate current estimate of the macroeconomic influences prevailing when the estimate was made. Furthermore, these estimates are calculated according to the different economic analyses of each analyst and investment
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house. Even the Forward curve structures are non-predictive, and at most, they represent the expectation and risk level embedded in the markets.
According to the structure of the Company's hedge transactions, on the settlement date vs. the financial entity with which the hedge was executed (settlement date of the trade), a calculation is made of the transaction's strike price vs. the average monthly price of the underlying asset (Asian options) (published by Platts, a division of McGraw-Hill companies, which is the authorized and leading international entity in the field of providing data services on the energy market) and constitutes an accepted point of reference with respect to the trading of oil and its derivatives. The payment or receipt for the transactions is based on the transaction's structure as designated in advance.
The financial instruments traded by the Company (mainly options on jet fuel) are traded over the counter (OTC) between the Company and the financial entities in conjunction with which the trade is executed, and are not contracts traded directly on various exchanges.
The future price of the jet fuel, as traded in these instruments, is comprised of three main elements: crude oil price, the Gas Oil crack and the jet differential.
Each of these three elements is actually traded separately (between financial institutions and brokers), and priced separately. The pricing of each of the elements is affected by various factors, including the current price, duration, price fluctuations, supply and demand, seasonal factors, storage costs, transport, etc, and has a different effect on the overall price change of jet fuel.
This pricing is done differently by every financial entity, according to models and algorithms that they developed (based on models such as Black & Scholes, Monte Carlo, etc.), opposite the investment portfolio of that party.
As is accepted in this field by global aviation companies, the companies obtain the fair value estimates from the investment houses opposite which they execute the trades. These investment houses use macroeconomic models that take into account the individual behavior of each element, the proportionate mix in the formula among the elements, the individual fluctuation of each element, the cross-influence between prices and fluctuation and between supply and demand (supply and demand flexibility), future development of production, refining, storage and transport (tankers and pipes) capabilities, world geopolitical forecasts and the behavior of the cartels, macroeconomic models of global growth rates and demand for energy sources, forecasts for changes in interest and exchange rates, production forecasts for alternative energy sources for the materials being discussed, the behavior of the financial markets in connection with trade in the relevant securities and derivatives and other factors. All the above elements are processed according to economic models that were developed by the different investment houses that own them. These models are capable of generating estimates and forecasts, with the qualification that they are correct as of the moment they are generated. Some of the investment houses use the "Monte Carlo" simulation model on these estimates, in order to predict the future price/value expectancy.
In this report, we rely on fair value calculations made by the various financial entities with which the transactions were executed and were provided the Company.
Presented below is a sensitivity analysis of the fair value of the financial instruments sensitive to possible changes in the risk factors to which they are exposed. The analyses pertain to the fair value of the financial instruments as of December 31, 2010.
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Presented below are sensitivity analysis tables for instruments sensitive to changes in market factors:
a. Sensitivity to changes in the NIS/USD exchange rate – in thousands of dollars:
Gain (loss) from changes Gain (loss) from changes Increase 10% Increase 5% Fair value Decrease 5% Decrease 10% 3.904 3.726 3.549 3.372 3.194 NIS/$ NIS/$ NIS/$ NIS/$ NIS/$ Cash and cash equivalents (1,205) (631) 13,260 698 1,473 Short-term deposits (779) (408) 8,565 451 952 Trade receivables (101) (53) 1,114 59 124 Other receivables (792) (415) 8,717 459 969 Current derivative financial instruments (1,106) (580) 12,170 641 1,352 Long-term bank deposits (170) (89) 1,869 98 208 Investments in other companies (939) (492) 10,324 543 1,147 Total financial Assets (5,093) (2,668) 56,019 2,948 6,224 Short-term borrowings and current maturities 69 36 (761) (40) (85) Trade payables 2,971 1,556 (32,680) (1,720) (3,631) Other payables - Current 165 86 (1,814) (95) (202) Other payables - Non Current 403 211 (4,437) (234) (493) Total financial liabilities 3,608 1,890 (39,692) (2,089) (4,410) Exposure in linkage balance sheet due to surplus financial liabilities over financial assets (1,484) (777) 16,327 859 1,814
* Does not include exposure for the effect of the changes in the exchange rate on assets and liabilities
due to employee benefits; see Section a.4. b. Sensitivity to changes in the EUR/USD exchange rate - in thousands of dollars:
Gain (loss) from changes Gain (loss) from changes Increase 10% Increase 5% Fair value Decrease 5% Decrease 10% 0.824 0.787 0.749 0.712 0.674 Euro/$ Euro/$ Euro/$ Euro/$ Euro/$ Cash and cash equivalents (424) (222) 4,667 246 519 Trade receivables (1,353) (709) 14,879 783 1,653 Other receivables (47) (24) 514 27 57 Total financial Assets (1,824) (955) 20,060 1,056 2,229 Trade payables 2,290 1,200 (25,194) (1,326) (2,799) Other payables 323 169 (3,555) (187) (395) Total financial liabilities 2,614 1,369 (28,749) (1,513) (3,194) balance sheet due to surplus financial liabilities over financial assets 790 414 (8,689) (457) (965)
* Does not include exposure for the effect of the changes in the exchange rate on assets and liabilities
due to employee benefits, see Section a.4.
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c. Sensitivity to changes in jet fuel prices on inventory (dollar/gallon) – in thousands of dollars:
Gain from changes Loss from changes Type of instrument Increase 10% Increase 5% Fair value Decrease 5% Decrease 10% 2.955 2.820 2.686 * 2.552 2.417 $/gallon $/gallon $/gallon $/gallon $/gallon Jet fuel Inventory 1,025 512 10,248 (512) (1,025)
* Jet fuel prices according to moving weighted average as of December 31, 2010.
d. Sensitivity of jet fuel hedging to changes in jet fuel prices - in thousands of dollars:
According to the model's principles, jet fuel hedges that react in a similar manner to market factors were grouped together, since there was no loss of material information required to understand the Company's exposure to market risks as a result of the grouping. On January 5, 2009 jet fuel prices changed by 14%, and therefore the following sensitivity analysis includes a 15% change in jet fuel prices.
Gain from changes Loss from changes Type of instrument Increase Increase Increase Fair value* Decrease Decrease Decrease 15% 10% 5% 5% 10% 15% 2.807 , 2.878 2.685 , 2.753 2.563 , 2.628 2.441 , 2.503 * 2.319 , 2.378 2.197 , 2.253 2.075 , 2.128 $/gallon $/gallon $/gallon $/gallon $/gallon $/gallon $/gallon SWAP transactions - designed for hedging 36,300 24,200 12,100 34,311 (12,100) (24,200) (36,300)
* The price of jet fuel in the Mediterranean Basin ($2.441/gallon) and Northwest Europe ($2.503/gallon) as of December 31, 2010, according to which the fair value of the Company's jet fuel hedging transactions is calculated. e. Sensitivity of interest hedging to changes in market interest rates – in thousands of dollars:
According to the principles of the model, an aggregation was made of interest hedging instruments that respond in a similar way to market factors (IRS agreements intended for hedging, IRS agreements not intended for hedging), since no loss of significant information is sustained that is required to understand the Company's exposure to the market risks, as a result of the grouping. On December 16, 2008 a 75% change occurred to the dollar monetary policy, and therefore the following sensitivity analysis led to a 75% change in interest rates.
Gain from changes Loss from changes Type of instrument Increase Decrease Decrease 10% 10% 75% Increase 75% in interest Increase 5% Fair value * Decrease 5% in interest in interest in interest rate rate in interest rate in interest rate rate rate IRS transactions - designed for hedging 0.27 0.04 0.02 (300) (0.02) (0.04) (0.27) IRS transactions - not designed for hedging 2,047 269 132 (19,937) (137) (277) (2,078) Cylinder transactions - not designed for hedging 0.19 0.02 0.01 (1,831) (0.01) (0.02) (0.18) Total 2,047 269 132 (22,068) (137) (277) (2,078)
* Fair value was calculated according to the market Libor rate as of the report date, at the following rates: 3- month Libor: 0.30%, 6-month Libor: 0.46%, and 12-month Libor 0.78%, all as applicable and according to the relevant transaction.
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f. Sensitivity of NIS/USD exchange rate hedging to changes in market exchange rates – in thousands of dollars:
Loss from changes Gain from changes Type of instrument Increase 5% Increase 10% in Decrease 5% Decrease 10% in exchange exchange Fair value in exchange in exchange rate rate NIS/$ * rate rate 3.904 3.726 3.549 3.372 3.194 FORWARD transactions - designed for hedging (16,637) (8,321) 12,170 8,316 16,636
* The sensitivity analysis was carried out in shekel terms, and the profit or loss in the event of a 5% or 10% decrease or increase was translated according to an exchange rate of 3.549 NIS per USD on December 31, 2010. b.2 Linkage Basis Report The following is the consolidated linkage basis report for December 31, 2010:
In, or linked to In Israeli In, or linked to In, or linked to Non-monetary Total the US dollar currency the euro the other items currencies (in thousands US dollars) Current assets Cash and cash equivalents 81,807 13,260 4,667 11,268 - 111,002 Short-term deposits 55,000 8,565 - - - 63,565 Trade receivables 104,504 1,114 14,879 12,463 - 132,960 Other receivables 10,551 8,717 514 1,098 - 20,880 Derivative financial instruments 30,020 12,170 - - - 42,190 Prepaid expenses - - - - 26,995 26,995 Inventory - - - - 18,756 18,756 Non-current assets Long-term bank deposits - 1,869 - - - 1,869 Investment in affiliated companies - - - - 693 693 Investments in another companies 1,228 10,324 - - - 11,552 Derivative financial instruments 4,291 - - - - 4,291 Fixed assets, net - - - - 1,231,687 1,231,687 Intangible assets, net - - - - 7,844 7,844 Assets due to employee benefits 143 38,656 - - - 38,799 Prepaid expenses - - - - 8,121 8,121 287,544 94,675 20,060 24,829 1,294,096 1,721,204 Current liabilities Short-term borrowings and current maturities (146,826) (761) - - - (147,587) Trade payables (88,098) (32,680) (25,194) (11,940) - (157,912) Other payables (40,717) (1,814) (3,555) (3,539) - (49,625) Provisions (9,192) (35,747) - - - (44,939) Derivative financial instruments (2,329) - - - - (2,329) Employee benefit obligations (3,690) (93,536) (767) (719) - (98,712) Unearned revenues - - - - (231,204) (231,204) Non-current liabilities Loans from financial institutions (561,084) - - - - (561,084) Employee benefit obligations (7,813) (52,092) (675) (5,010) - (65,590) Other payables (6,263) (4,437) - - - (10,700) Derivative financial instruments (19,739) - - - - (19,739) Deferred tax - - - - (32,792) (32,792) Unearned revenues - - - - (51,467) (51,467) Shareholders’ equity - - - - (247,524) (247,524) (885,751) (221,067) (30,191) (21,208) (562,987) (1,721,204) Monetary assets, net of monetary liabilities (monetary liabilities, net of monetary assets) (598,207) (126,392) (10,131) 3,621 731,109 -
The following is the consolidated linkage basis report for December 31, 2009:
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In, or linked to In Israeli In, or linked to In, or linked to Non-monetary Total the US dollar currency the euro the other items currencies (in thousands US dollars) Current assets Cash and cash equivalents 80,342 8,494 7,496 10,355 106,687 Short-term deposits 7,933 7,933 Restricted deposits 7,003 7,003 Trade receivables 92,993 788 9,301 9,004 112,086 Other receivables 7,119 5,915 1,744 1,377 16,155 Derivative financial instruments 6,469 4,737 11,206 Prepaid expenses* 20,395 20,395 Inventory 21,947 21,947 Non-current assets Long-term bank deposits 1,839 1,839 Investment in affiliated companies 648 648 Investments in another companies 1,357 1,357 Derivative financial instruments 2,255 2,255 Fixed assets, net 1,312,930 1,312,930 Intangible assets, net 7,504 7,504 Assets due to employee benefits 118 34,383 34,501 Prepaid expenses* 7,056 7,056 197,656 64,089 18,541 20,736 1,370,480 1,671,502 Current liabilities Short-term borrowings and current maturities (105,437) (521) (58) (106,016) Trade payables (69,030) (25,099) (23,298) (11,543) (128,970) Other payables (46,010) (1,819) (3,231) (3,384) (54,444) Provisions (5,911) (51,306) (57,217) Derivative financial instruments (55,643) (55,643) Employee benefit obligations (2,819) (77,671) (510) (379) (81,379) Unearned revenues (204,444) (204,444) Non-current liabilities Loans from financial institutions (704,194) (704,194) Employee benefit obligations (7,794) (52,035) (893) (5,113) (65,835) Other payables (13,318) (13,318) Derivative financial instruments (20,135) (20,135) Deferred tax (5,313) (5,313) Unearned revenues (50,813) (50,813) Shareholders’ equity (123,781) (123,781) (1,030,291) (207,930) (28,453) (20,477) (384,351) (1,671,502) Monetary assets, net of monetary liabilities (monetary liabilities, net of monetary assets) (832,635) (143,841) (9,912) 259 986,129 -
*Reclassification
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c. Aspects of Corporate Governance:
c.1 Charitable Contributions and Community Work El Al assigns a great deal of importance to making charitable contributions and assisting the needy and its community. As part of its activities, the Company contributed in 2010, in cash and cash equivalents, a sum of $370 thousand ($100 thousand in 2009).
Over the course of 2010, El Al continued its long-standing tradition of giving back to the community.
The activity continued to focus mainly on two channels:
1. Employee volunteer activities within the scope of the departmental steering committee for weaker populations, including holocaust survivors without relatives, at-risk children, special-needs children, people with disabilities and the infirm;
2. Support with money or money-equivalents, for the needy:
a. By management – within the framework of the Contributions Committee, the Company contributes considerable sums of money, and in addition contributes assistance in the form of money equivalents, such as dozens of hot meals a day, free flight tickets, transport of special cargo free-of-charge and the distribution of food containers. Furthermore, the Company has assisted the town of Kfar Orad in northern Israel, which was damaged in the Carmel disaster. In addition, El Al has donated to organizations assisting the mentally challenged (AKIM, Etgarim, Pitchon Lev, Larger than Life, the Israeli Youth Diabetes Association), and El Al has adopted the soldiers of the IDF’s 201st Battalion as part of the "Adopt a Warrior" program.
b. By the employees themselves – whether in money or money-equivalents (electrical appliances, clothing, books, games, etc.) to kindergartens for special-needs children, at-risk children’s homes and more. c.2 Directors with Accounting and Financial Capabilities
a) Under the Companies Law, 1999, and the regulations enacted under its auspices regarding the reporting about directors with accounting and finance skills, the Company's Board of Directors resolved that the minimum number of directors with accounting and finance skills in the Company would be one-third of the number of directors serving at any time. As of the approval date of the Financial Statements, twelve directors are serving the Company, and therefore, the minimum number of directors with accounting and finance skills is four directors. In the opinion of the Board of Directors, considering the scope and complexity of the Company's operations, this number of directors with accounting and finance skills will enable the Company's Board of Directors to meet the obligations imposed on it, especially as relates to the examination of the Company's financial position, preparation of Financial Statements and their approval. As of the Financial Statement approval date of the Company four directors with accounting and financial skills serve on the Company’s Board of Directors.
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b) Presented below are the details of the directors possessing accounting and finance capabilities, including the facts by virtue of which they are seen as such:
Mr. Nadav Palti – Director of the Company since January 2005. Mr. Palti is an accountant by training and serves as Chairman of Mapal Communications Ltd. and as CEO and President of Dori Media Group Ltd.
Mr. Yair Rabinowich – Outside director at the Company since February 2007 (his term in office was extended for an additional period starting March 1 2010). Mr. Rabinowich has been a certified public accountant since 1970. Owns a firm specializing in taxation and finance and in the past served as the managing partner of a large CPA firm, and also served as Commissioner of Income Tax and Property Tax. Served in the past as a member of the Bank of Israel advisory committee on banking matters and as a member of the presidency of the Institute of Certified Public Accountants, and also served as a lecturer in institutes of higher education.
Professor Jhoshua (Shuki) Shemer – outside director at the Company since November 2008. Prof. Shemer is an expert on internal medicine and medical administration. Serves as Chairman of the Board of Assuta Medical Centers Ltd. since 2005 and has served as CEO of Maccabi Health Services.
Mr. Pinchas Ginsburg – a Company director since June 2009. Mr. Ginsburg has a degree in economics and accounting, manages tourism companies and serves on the boards of several companies.
c.3 Disclosure Regarding Independent Directors
The Company has not adopted in its bylaws the ordinance regarding the number of independent directors, in accordance with Section 219 (a) of the Companies Law, 1999. c.4 Disclosure about Internal Auditor of Reporting Corporation
1. Information Regarding the Internal Auditor and Compliance with Conditions 1.1.1. Name of Auditor: Gil Ber. 1.1.2. Beginning of term in office: June 1 2009. 1.1.3. Qualifications: Accountant, with a degree in Accounting and Business Administration and certified in public administration and auditing (with honors). Holds a CIA (Certified Internal Auditor – U.S.) certificate. Has 15 years experience in auditing, in financial statements and in risk management. Until his appointment Mr. Ber was a partner in Cost Forer Gabai & Ksirrer, Ernst & Young, responsible for auditing and risk management, and served as internal auditor for various companies and organizations. A regular lecturer at the Academic Track of the College of Management on budgeting and control subjects. The Internal Auditor meets all compliance requirements set in Section 3(a) of the Auditing Law. The Internal Auditor complies with Section 146(b) of the Companies Law and Section 8 of the Internal Auditing Law. 1.1.4. The Internal Auditor has no holdings in Company securities or holdings in any related body in the reported year.
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1.1.5. Starting from the date of his appointment, the Internal Auditor has had no business connections of any sort with the audited corporation or with any related body, with the exception of serving as Internal Auditor of Group subsidiaries. 1.1.6. The Internal Auditor is employed by the Company as a full-time Company employee.
2. The Internal Auditor's Appointment 2.1. The appointment of the internal auditor was approved by the Audit Committee on its April 21 2009 meeting and by the Company's Board of Directors on its April 30 2009 meeting and after considering the Auditor's education, skills and experience in corporate auditing and risk management to material degrees. 2.2. The Auditor was provided with duties and authorities in accordance with the Company's auditing procedure, the directives of which are based on the laws of the State of Israel. Pursuant to this, the Internal Auditor was tasked with proposing a work plan, to be carried out in accordance with the Company’s auditing plans and to distribute, in writing, reports containing findings, conclusions and recommendations.
3. The Internal Auditor's Supervisor 3.1. The Internal Auditor is subordinate to the Chairman of the Board of Directors and the Company CEO, in accordance with the Company's bylaws.
4. Work Plan 4.1. The Internal Auditor's work plan is on a yearly basis. 4.2. The Internal Auditor's work plan is determined based upon the following considerations: 4.2.1. The risk embodied in an area of activity and the Company's profitability. 4.2.2. The existence of appropriate controls, applicability and efficiency in the audited area. 4.2.3. Proposals by VPs and branch managers. 4.2.4. Previous audit findings and the pace at which the recommendations submitted were implemented. 4.2.5. The effect of the subject on Company profitability, passenger service, the safety and security of passengers, employees and aircraft, 4.2.6. The need for follow-up in order to guarantee an appropriate auditing process. 4.3. Establishment of the work plan involves the Chairman of the Company's Board of Directors, the members of the Audit Committee and the Company CEO. 4.4. The proposed work plan is received on an annual basis by the Chairman of the Company's Board of Directors, the members of the Audit Committee and the Company CEO. All of them approve the proposal in accordance with Section 149 of the Companies Law. 4.5. The work plan allows the Internal Auditor to exercise his judgment in deviating from the plan. 4.6. The Company Auditor is present at Board meetings in which material transactions are approved.
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5. Overseas Audits for Subsidiaries 5.1. The Company Auditor also serves as the Internal Auditor for all active subsidiaries and therefore the Auditor's work plan takes these companies into account. The Auditor's work plan also includes reviews of the Company's overseas activities.
6. Scope of Employment 6.1. The Internal Auditor is employed full time by the Company and subordinate to him are six full time auditors. 6.2. The following work hours were invested in auditing the Company and its overseas subsidiaries in 2010:
Work hours for the Work hours for the Work hours due to Total hours Company's activity in Company's activity investee corporations** Israel abroad* 10,320 1,800 1,000 13,120
* 70% of the Company's work hours for activities abroad were carried out in Israel. ** Audits were conducted for 2 subsidiaries.
7. Auditing Proceedings 7.1. The Company's Internal Auditor conducts his work in accordance with the Companies Law, 1999, the Internal Audit Law, 1992 and generally accepted professional standards. 7.2. The Chairman of the Board holds a monthly meeting with the Internal Auditor regarding his work and regarding the professional standards according to which the Auditor operates. 7.3. The Audit Committee holds meetings in which it discusses the Internal Auditor's work and the audit standards. 7.4. Prior to the approval of the yearly audit plan the Chairman of the Board meets with the Internal Auditor to discuss the standards according to which the work plan was formulated, following which the audit committee discussed the proposed yearly audit plan and the standards according to which the proposal was formulated and approves it.
8. Access to Information 8.1. The Internal Auditor has free, continuous and direct access to any document or information held by the Company or by one of its employees, as well as access to any ordinary or computerized data base, to any data base and to any automatic data processing system in the Company, including financial data, as noted in Section 9 of the Internal Audit Law.
9. Internal Auditor Reports 9.1. The audit reports are submitted in writing.
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9.2. The Internal Audit Branch prepared 30 audit reports in 2010. The audit reports were submitted to the Chairman of the Board, the members of the Audit Committee of the Board of Directors, and to the Company's CEO. 9.3. In 2010, the Audit Committee convened 8 times to discuss the internal audit reports.
10. The Board of Directors' Evaluation of the Internal Auditor's Activity In the opinion of the Board of Directors, the scope, nature and continuity of the internal auditing activities and work plan are reasonable under the circumstances, and they achieve the internal audit objectives of the corporation, as they relate to all of the Company’s material and key activities.
11. Remuneration 11.1. The compensation of the internal auditor is based on the salary and associated benefits granted members of the senior management group and in accordance with Company policy. 11.2. In the opinion of the Company's Board of Directors, the compensation given to the Internal Auditor and its components do not impair his ability to use independent judgment in carrying out his assignments, inter alia, in view of the fact that the audit work is performed through several Internal Auditors.
c.5 Disclosure Regarding Independent Auditors' Fees
On November 30, 2006, the Securities Authority issued a guideline under Section 36.a.(b) of the Securities Law, 1968, regarding disclosure of the independent auditors' fees for audit services and audit-related services, for tax services and for other services.
Below are the Company's fee expenses to Brightman Almagor Zohar & Co., CPAs:
Audit and tax services Additional services
Hours Thousands of Hours Thousands of dollars dollars
2010 8,257 261 1,218 45
2009 9,909 377 51 4
The decrease in auditing hours relative to 2009 derives from the fact that the auditing hours invested in the Company’s representatives are not included in the sum of hours for 2010 and most of them were given in the period subsequent to the balance sheet date.
Most of the increase in the scope of hours in the field of additional services invested in 2010 vs. 2009 mainly derives from the application of the Securities Authority regarding the examination of the effectiveness of internal controls in the corporation (I-SOX) for the first time.
These fees were approved by the Company's Board of Directors and are reasonable and acceptable according to the nature of the Company and the extent of its activities.
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c.6 Disclosure in the Report of the Board of Directors Regarding the Financial Statements’ Approval Process
The body charged with ultimate control in the Company regarding the approval of the Financial Statements is its Board of Directors. Starting from the approval of the 2010 yearly Financial Statements, the financial statement approval process is covered by directives set in the Companies Regulations (Directives and Conditions for the Financial Statement Approval Process), 2010 (“the Regulations”).
Within the framework of the Board of Directors, the Company operates several committees, including the Audit Committee, the Market Risks Management Committee, the Human Resources and Appointments Committee and the Government Affairs and Regulations Committee.
In addition, the Company also has a Finance, Budget and Balance Sheet Committee, which according to the Regulations discusses the Yearly Financial Statements prior to bringing them before the Board of Directors for approval and recommends to the Board of Directors whether to approve the Company’s Financial Statements.
The following three members serve on the Financial Statements Examination Committee:
1) Mr. Yair Rabinowich, Chair of the Committee, independent director (outside director). Possessing accounting and financial qualifications, holding an accounting certificate from the Hebrew University in Jerusalem. Owns a tax consulting firm and is fluent in accounting issues and financial statement preparation. Mr. Rabinowich provided a statement prior to his appointment.
2) Professor Jhoshua Shemer, independent director (outside director). Possessing accounting and financial qualifications, with a degree in internal medicine and an expert in medical administration on behalf of the Ministry of Health. Professor Shemer serves as the Chairman of the Board of Directors of Assuta Medical Centers and formerly served as General Manager of Maccabi Health Services. Professor Shemer has extensive business experience, mainly in managing major corporations and is capable of and experienced in reading financial statements. Professor Shemer provided a statement prior to his appointment.
3) Mr. Nadav Palti, dependent director. Possessing accounting qualifications, economics and accounting graduate from Tel Aviv University and CPA. Serves as President and CEO of Dory Media Group and serves on the boards of many additional corporations. Mr. Palti has extensive experience in understanding financial statements and provided a statement prior to his appointment.
The Finance, Budget and Financial Statements Committee meets for extensive and thorough discussion of the draft Financial Statements, in the presence of the auditing accountant. The Chief Executive Officer and the Chief Financial Officer present the members of the committee with extensive details on the Financial Statements, including detailed financial analyses about the Company's performance during the reporting period.
The Financial Statement Examination Committee studies the material issues in financial reporting and formulates a recommendation for the Company’s Board of Directors pertaining to, among other things, the following issues: (a) estimates and evaluations made pursuant to the Financial Statements; (b) internal controls pertaining to financial reporting; (c) the wholeness and propriety of disclosure in the Financial Statements; (d) the accounting policy adopted and the accounting treatment applied to material Group issues; (e) value estimates, including underlying assumptions and estimates, on which the data in the Financial Statements was based. The Committee also reviews different aspects of control and risk management, both those reflected in the Financial Statements and those impacting the reliability of the Financial Statements.
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When complex or significant issues are on the agenda, special discussions are held by the Finance, Budget and Financial Statements Committee about the matter on the agenda with the participation of the independent auditor.
The Company’s Board of Directors is the organ that discusses and approves the Financial Statements, after the members of the Board receive the draft Financial Statements and the recommendations of the Financial Statements Examination Committee at least two business days prior to meeting.
Over the course of the Board meeting in which the Financial Statements are discussed and ratified, the Company CFO provides a detailed review of the key points of the Financial Statements and the Company’s accounting policy. The CEO also reviews the Company's current activity and the influence of this activity on the Company’s Financial Statements and emphasizes material issues. In addition, Chairman of the Financial Statement Examination Committee reviews the key points of the Committee’s recommendations.
Invited and present at the Board meeting in which the Financial Statements are discussed and ratified are representatives of the Company’s auditing accountant, who provide remarks and clarifications to the Financial Statements and who are at the Board members’ disposal to answer questions and provide clarifications regarding the reports prior to their approval.
In order to formulate their recommendations for the Board of Directors, on March 17, 2011 and March 20, 2011 the Financial Statements Examination Committee convened in full. Also taking part in the meetings in question were representatives of the Company’s auditing accountant and internal auditor, Mr. Gil Ber, along with the Chairman of the Board of Directors, Mr. Amikam Cohen, the Company CEO, Mr. Elyezer Shkedy, the CFO, Mr. Nissim Malki and the Legal Counsel and Company Secretary, Mr. Omer Shalev, esq.
The Financial Statements Examination Committee held a discussion about the Financial Statements presented to it, including directing questions to the members of management present and to the independent auditor. Likewise, the independent auditor is asked to present his comments, if any, to the committee members – including accounting policy applied and special events that arose during the review of the Financial Statements.
The following are details of the processes taken prior to the approval of the December 31, 2010 Financial Statements.
(a) The draft Financial Statements were provided to the members of the Board of Directors on March 16, 2011. (b) Board members are welcome to contact the Company CFO at any time with any question or clarification they require, prior to the Committee meeting. (c) At the Finance Committee meeting, the Committee reviewed Group financial results, viewed a comparison of the reported period to corresponding periods and received details of changes made due to the application of new standards, presented by the Company CFO and auditing accountant. (d) Pursuant to its meeting the Committee studied the estimates and assessments carried out in relation to the 2010 Financial Statement, the wholeness and propriety of disclosure in the 2010 Financial Statements, the accounting policy adopted and accounting treatment implemented regarding the Company's material issues. (e) During this meeting, the auditing accountants present the Committee with any major issues raised during their audit. (f) The Committee discusses the effectiveness of internal controls of financial reporting and disclosure in the Company and examined among other things the process of the Company’s estimates regarding
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internal control processes required to examine the effectiveness of internal controls over financial reporting and disclosure, including the process of identifying and establishing material processes in the Financial Statements based on qualitative and quantitative mapping, this via detailed presentation on behalf of the Company’s CFO. At the conclusion of the discussion, it was determined that a material weakness exists regarding the process of approving the employment of the outgoing CEO, as detailed in Chapter E (Yearly Report on the Effectiveness of Internal Controls over Financial Reporting and Disclosure), below. (g) At the conclusion of the discussion, and after it has been clarified that the Financial Statements adequately reflect the state of Company affairs and its operating results, the Committee recommended that the Board of Directors approve the Financial Statements. (h) The Committee’s recommendations were provided to the members of the Board of Directors on March 20, 2011 in writing. (i) After receiving the Committee’s recommendations, a revised draft of the Financial Statements was provided to the members of the Board of Directors. (j) The Company Board of Directors discussed the Committee’s recommendations as part of the Board meeting held on March 22, 2011. The Board of Directors believes that the Committee’s recommendations were provided in a reasonable amount of time prior to the discussion by the Board of Directors taking intro account the scope and complexity of the recommendations.
On March 22 a discussion was held by the Company Board of Directors regarding the recommendations of the Financial Statements Examination Committee. At the conclusion of the Board meeting, the December 31, 2010 Financial Statements, prepared on the basis of IFRS rules, were approved unanimously. Present at the Board of Directors Meeting in which the Financial Statements were approved were the following Board members: Amikam Cohen, Tamar Mozes-Borowich, Yehuda Levi, Nadav Palti, Eran Ilan, Yair Rabinowich, Professor Shuki Shemer, Shlomo Hannael, Pinchas Ginsburg and Sofia Kimmerling.
The recommendations of the Financial Statements Examination Committee were provided the Board of Directors two business days prior to the discussion on the Financial Statements by the Company’s Board of Directors. In the Board meeting held March 16 2011 the members of the Board of Directors stated that in light of the scope and complexity of the recommendations, this constituted a reasonable amount of time for the receipt of the material. c.7 Use of Securities Proceeds
Pursuant to the commitment given by the Company and by the State of Israel, as expressed in the 2003 prospectus, the proceeds of the State's and the Company's offerings in recognized severance funds are recognized for the purpose of securing severance payments.
After making these deposits and covering the full deficit in the severance fund as required by the agreement, the Company deposited 30.4 million NIS, (including interest accrued to as of this report) constituting the balance of the offering proceeds, in a special account (included in short-term deposits as of December 31, 2010). The Company is evaluating the existence of limitations related to its ability to use the proceeds balance, pursuant to the aforementioned agreement, between it and the State and the employees' representatives, and in this connection, the Company communicated to the State. As of the date of the report,
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negotiations are taking place with the General Comptroller’s Office at the Ministry of Finance in order to examine entitlement to issue surpluses. For further details see Notes 6.b and 23.b.3 to the December 31 2010 financial statements.
c.8 Disclosure Regarding Consent to Perform Peer Review
On July 28, 2005, the Securities Authority issued a guideline under Section 36a of the Securities Law, 1968 regarding disclosure of consent given to perform peer review, the objective of which, according to this guideline, is to spur the process of controlling the work of accounting firms and testing the existence of requisite procedures during the audit work performed, which will contribute to the existence of an advanced capital market.
On March 29, 2006, the Company Board of Directors provided the necessary consent for undertaking the peer review.
c.9 Negligible Transaction
On November 26, 2009, the Company Board of Directors decided to adopt rules and guidelines for the classification of a transaction made by the company or one of its affiliates with an interested party (hereinafter: "an Interested Party Transaction") as a negligible transaction as defined in Regulation 64(3)(d)(1) of the Securities Regulations (Preparation of Yearly Financial Statements), 19931.
These rules and guidelines are also used to determine the extant of disclosure in the periodic report and in the prospectus (including in shelf proposal reports) as regards transactions with controlling shareholders or in which controlling shareholders have personal interest as defined in Regulation 22 of the Securities Regulations (Periodic and Immediate Reports), 1970 (hereinafter: "the Reporting Regulations), and Regulation 54 of the Securities Regulations (Prospectus Details and Prospectus Draft – Structure and Form), 1969, as well as to determine the need to submit an immediate report for such a transaction, as set in Regulation 37(a)(6) of the Reporting Regulations.
The Company's Board of Directors has determined that in the absence of special qualitative considerations deriving from the circumstances of the issue, an Interested Party Transaction shall be considered a "negligible transaction" if:
(a) The transaction takes place over the Company's normal course of business and (b) the transaction is under market conditions and its terms are acceptable to the relevant market; and – (c) the relevant criteria for the transaction, one or more, whether it is a single commitment or a series of commitments on the same issue over the course of the same year, is at an extant of no greater than 200,000 NIS in any interested party transaction the classification of which has been considered as a "negligible transaction" on the basis of the Company's latest audited consolidated yearly financial statements. Relevant criteria for the determination of a transaction are, for instance: (1) total sales the subject of the Interested Party Transaction; or – (2) the total cost of the sales the subject of the Interested Party Transaction; or – (3) the extant of assets the subject of the Interested Party Transaction; or – (4) the extant of liabilities the subject of the Interested Party Transaction; or – (5) the extant of the expense or yield the subject of the Interested Party Transaction.
1 Or as defined in Regulation 41(a)(6)(a) of the Securities Regulations (Yearly Financial Statements), 2010.
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In this regard – in the event the Company does not have full rights to a certain transaction, the transaction shall be determined based on the Company's relative portion of the transaction.
In cases in which, according to the Company's judgment, all of the aforementioned criteria are irrelevant for the determination of the negligibility of the Interested Party Transaction, the transaction shall be considered negligible, in accordance with a different relevant criterion, determined by the Company, so long as the relevant criterion used for this transaction shall be no greater than 200,000 NIS.
At the same time, examination of the quantitative considerations of an interested party transaction may lead to the contradiction of the aforementioned presumption of the transaction's negligibility. Thus, for instance, and merely as an example, an Interested Party Transaction shall not generally be considered negligible if it is considered a significant event by Company Management and if it serves as basis for administrative decisions, or if interested parties are expected to receive benefits that need to be reported to the public as part of the transaction.
The transaction's negligibility shall be determined on a yearly basis for the purpose of reporting within the framework of the periodic report, the financial statements and the prospectus (including a shelf proposal report), while adding together all of the Company's transactions of the sort with the interested party in question or with corporations under the control of the interested party. To be clear – separate transactions carried out on a regular and repeating basis during a certain period with no mutual dependence or for which no additional obligations exist which are not relevant to entering into the transaction as regards the same interested party, shall be examined on a yearly basis for the purpose of reporting pursuant to the periodic report , the financial statements and the prospectus (including a shelf proposal report), and on the basis of the specific transaction for the purpose of immediate reporting. c.10 Connection Between Remuneration Given as per Regulation 21 and the Contribution of the Remuneration Recipient
For details regarding remunerations given senior Company executives in accordance with employment agreements with the Company, see Regulation 21 in Chapter D of this periodic report.
Upon their approval, the considerations guiding the Company's Board of Directors in determining salary payments to Company executives, were made after examining their contribution to the development of the Company's business, taking into account the provision of services required for the Company particularly in light of the current need to develop its business, as well as taking into account the knowledge, experience and skills possessed by these executives in the Company’s areas of activity, the state of its business and its financial results, as well as the payment given executives in corresponding positions in companies with characteristics similar to those of the Company.
Pursuant to the 2010 periodic report approval process, an additional discussion was held at the Company’s Board of Directors on the terms of employment and service of each executive, detailed in Regulation 21 of the Securities Regulations (Periodic and Immediate Reports) 1970 (“the Reporting Regulations”). The Board of Directors discussed, among other things, the relation between the sum of remunerations given in 2010 to each of the executives and their contribution to the Company in the reported period. For the sake of the discussion, the Board of Directors was presented with relevant data regarding each of the Company’s executives, as required in accordance with Regulation 21 of the Reporting Regulations and in accordance with Parts B and C of the Sixth Addendum to the Reporting Regulations as well as comparative data regarding payments given executives in similar positions after examining the Company's chief characteristics including the nature of its activities, its operating cycle, the number of employees in companies with a yearly income turnover of a scope similar to that of the Company.
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The Board of Directors determined that remuneration to each member of the Company's senior management is reasonable and fair in accordance with the following criteria: (a) the scope and areas of responsibility and complexity of the position they fulfill; (b) the executive's education, training and professional experience; (c) main terms of employment, including conditions for ending the commitment; (d) components of the remuneration given the executive in the reported period; (e) the contribution of the executive to the Company's business, its operating results, its stability and its compliance with the work plan in the reported year; (f) the executive's contribution to projects and unique tasks give them pursuant to their duties in the reported period; (g) the Company’s need to continue retaining the executive as possessor of unique capabilities, knowledge and expertise; (h) the executive’s compliance with the Company's expectations regarding the position in which they serve; (i) the executive's compliance with agreements made with them and (j) generally accepted terms of employment in the Israeli economy in the reported period, in positions similar to those filled by the CEO and VPs (benchmarks).
Summary of the Board of Directors’ Arguments Regarding the Remuneration of the Five Highest Recipients at the Company a. Company CEO – Mr. Elyezer Shkedy The Board of Directors examined the actions and contribution of the Company CEO, Mr. Elyezer Shkedy, to the Company over the course of his service in 2010. The Board of Directors examined the fairness and feasibility of the remuneration after receiving the CEO’s announcement regarding his decision to provide the “Excellence and People” Fund a total of 5.7 million NIS (gross), constituting 50% of the bonus owed him in accordance with his 2010 employment contract,. and therefore studied the remuneration awarded the CEO in practice after this announcement. The Board of Directors reviewed the CEO’s main actions and achievements, including successful negotiations with Boeing on equipping issues, fuel hedging transactions, opening the route to Eilat, reaching an agreement with Income Tax, purchasing holdings in Maman, expanding collaborations with other airlines, and dealing with the Icelandic volcano crisis. In the opinion of the Company's Board of Directors, taking the above into account, taking into consideration, among other things, the Company’s operating results in 2010, the activities and scope of the contribution of Mr. Elyezer Shkedy, the Board of Directors decided that the remuneration paid Mr. Elyezer Shkedy in practice for 2010 was fair and reasonable. b. VP of Operations (Former) – Mr. Lior Yavor The Board of Directors reviewed the actions and contribution of Mr. Lior Yavor to the Company over the course of his service in 2010, in accordance with the information it was provided as detailed above, and taking into account the fact that Mr. Yavor completed his term in office as the Company’s VP of Operations over the course of the reported period and no longer serves as a member of the Company's senior management. The Board of Directors has determined that Mr. Lior Yavor has complied with the terms of the agreement signed with him and with the demands of his position in a professional, loyal and responsible manner. Serving as VP of Operations in an airline involves a great deal of responsibility in light of the fact that the Company VP of Operations is responsible for the fields of safety and security at the Company. In the opinion of the Company's Board of Directors, taking the above into account, and also taking into consideration, among other things, the Company’s operating results, the activities and scope of the contribution of Mr. Lior Yavor, and in light of the agreements with him regarding the conclusion of employee-employer relations, remuneration paid Mr. Lior Yavor for 2010 was fair and reasonable. c. VP of Operations (Current )– Mr. Benjamin Livneh The Board of Directors reviewed the actions and contributions of Mr. Benjamin Livneh to the Company in 2010, particularly the execution of the Company's complex flight schedule in a safe, secure and economic
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manner, the management and control of exceptional incidents, the concentration of staff work of the Company's operational array, his handling of and responsibility for the Company's security budget and improvements made to the Company's operational precision. The Board of Directors has determined that Mr. Benjamin Livneh has complied with the terms of the agreement signed with him and with the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, and also taking into consideration, among other things, the Company’s operating results, remuneration paid Mr. Benjamin Livneh for 2010 was fair and reasonable. d. Chief Financial Officer – Mr. Nissim Malki The Board of Directors has studied the work and contribution made by Mr. Nissim Malki to the Company over the course of 2010, including in all matters pertaining to the management of the Company's financial array, preparation of the Company's Financial Statements, estimates and the Company's preparedness to implement the subject of the effectiveness of internal controls at the Company and its successful implementation, managing the Company’s cash flow and financial proceedings, managing the integration of the Company's equipping actions and activating safety teams at the Company to reduce its expenses. The Company's Board of Directors has determined that Mr. Nissim Malki has complied with the conditions requested from him and with the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, and also taking into consideration, among other things, the Company’s operating results, remuneration paid Mr. Nissim Malki for 2010 was fair and reasonable. e. VP of Maintenance and Engineering – Mr. Shmuel Kuzi The Board of Directors reviewed the actions and contribution of Mr. Shmuel Kuzi to the Company in 2010, particularly the increase in revenues from the field of maintenance, the maintenance of the largest fleet of aircraft in the Company’s history, the purchase, lease and upgrading of aircraft for the company and contribution to maintaining the highest level of operational precision in the field while meeting safety goals. The Board of Directors has determined that Mr. Shmuel Kuzi has complied with the terms of the agreement signed with him and with the demands of his position in a professional, loyal and responsible manner. In the opinion of the Company's Board of Directors, taking the above into account, and also taking into consideration, among other things, the Company’s operating results and comparative remuneration data presented to the Board of Directors, remuneration paid Mr. Shmuel Kuzi for 2010 was fair and reasonable. Regarding the Chairman of the Board of Directors, the service agreement signed with the Chairman includes salary and options, as detailed in Note 38d and Note 30.g.(6) to the December 31, 2010 Financial Statements. The Board of Directors examined the actions and contribution of Mr. Amikam Cohen to the Company in 2010, particularly the cooperation between him and the Company CEO and his leadership of the Company in 2010, in light of his extensive business experience. In the opinion of the Company's Board of Directors, after reviewing the contribution and actions of the Chairman of the Board of Directors, taking the above into account, and also taking into consideration, among other things, the Company’s operating results, remuneration paid Mr. Amikam Cohen for 2010 was fair and reasonable. c.11 Audit Report – Securities Authority
On March 10, 2011, the Securities Authority provided the Company with an audit report regarding the terms of the employment of senior Company executives, including the Company's outgoing CEO, Mr. Chaim Romano. For details on this issue, including regarding decisions made following the audit report in question, see immediate reports published by the Company on March 10, 2011 (reference numbers: 2011-01-075912 and 2010-01-075966) and on March 14 2011 (reference number: 2011-01-080034).
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d. Disclosure Provisions with Regard to Financial Reporting by the Corporation
d.1 Events Subsequent to the Balance Sheet Date Regarding events subsequent to the balance sheet date, see Note 42 to the December 31, 2010 Financial Statements. d.2 Critical Accounting Estimates Regarding critical accounting estimates, see Note 4 to the December 31, 2010 Financial Statements. d.3 Explanation of the Matter to which the Company's Independent Auditors Draw Attention in their Opinion Regarding the Financial Statements The Company’s accountants direct your attention, in their opinion featured in the Financial Statements, to the existence of a material weakness regarding the Company’s entity-level controls (ELC) in the context of processes pertaining to the approval of the terms of service and employment of Company executives, including the outgoing CEO.
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e. Additional information:
e.1 Dividend Distribution Policy On November 20, 2007, the Company's dividend policy was updated. Pursuant to the new dividend policy, the Company will distribute dividends from time to time at the discretion of the Board of Directors and subject to the Company's needs.
e.2 Disclosure Regarding Changes in the Economic Environment, the Implications of the Capital Market Crisis and Market Risks a) The international aviation industry is affected by the global security situation and by political and unusual events, such as the outbreak of epidemics and natural disasters in the world in general, and in specific areas in particular, as well as by the economic situation in Israel and around the world.
The extraction from the global financial crisis that began in the third quarter of 2009 continued in 2010. According to IATA (International Air Transport Association) information, in 2010 international passenger traffic increased by 8.2%, airborne cargo shipping increased by 20% and the average aircraft load factor amounted to 78.4%. Airlines also concluded the year with good results compared to the first few months of 2008, before the financial crisis began. At the same time, according to IATA estimates, expected profits in 2010 represent a net profit percentage of just 2.7%.
The Company reviewed its risk management policy in 2010, and subsequent to the balance sheet date began implementing its new hedging policy approved by the Board of Directors in December 2010. For details regarding the new policy see Notes 32e, 31f and 31g as well as Note 31 to the Financial Statements.
Since the end of 2010 the following changes have occurred in jet fuel prices, dollar interest rates and the USD/NIS exchange rate: b) Immediately prior to the publication of this report, jet fuel prices increased significantly mainly due to the instability in the Middle East and concerns regarding its impact on the worlds fuel supply. As of the Balance Sheet date (December 31 2010) the price of jet fuel in the Fob Med region was 244.11 cents per gallon, while as of immediately prior to the approval of the 2010 report this price has reached 314.2 cents per gallon, a 29% increase. Note that jet fuel expenses constitute nearly 30% of the Company’s turnover, and therefore the price increases may have a material impact on its financial results. The effective price the Company is expected to pay for jet fuel consumption (after hedging) in January and February 2011 is 6% higher than the average effective price paid in 2010. At the same time, the fair value of jet hedging instruments shall be set in accordance with price changes which occurred since the end of the year and the completion of accounting for some of the transactions. In January and February 2011 the Company continued to conduct hedging transactions for some of the fuel consumption expected over the course of 2011 and 2012, this in accordance with the new hedging policy as noted above. Following the increase in jet fuel prices the Company decided to update its fuel surcharge starting April 1 2011. c) Subsequent to the balance sheet date and until a date immediately prior to the approval of the yearly report, a 2% increase occurred in three-month Libor interest rates.
The impact of the change in Libor rates in the payment of interest on loans shall be evident in the next repayment date for each loan. The interest payments on Company loans for the first quarter of 2011 shall be made according to interest rates in previous quarters. The Company possesses hedging agreements for Libor
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rates (see Section b.1.(4) above), the fair value of which is expected to drop as a result of the decrease in Libor interest rates. d) Subsequent to the balance sheet date, no significant changes occurred in the exchange rate of the NIS vs. the USD, compared to the exchange rate as of December 31 2010. The Company has hedging agreements on the NIS/USD exchange rate (see b.1.(5) above), the fair value of which may change according to changes in exchange rates. Note that the impact of exchange rates on next quarter's operating results shall be determined based on exchange rates in effect throughout the quarter and at its conclusion (March 31 2011). Over the course of February 2011 the Company carried out exchange rate hedging transactions for an additional 13- month period ending February 2012, this in accordance with the Company’s hedging policy.
The Board of Directors thanks the Company's management and employees for their devoted work and efforts for the development of the Company and promoting its businesses.
Amikam Cohen Elyezer Shkedi Chairman of the Board CEO
March 22, 2011
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Appendix to the Report of the Board of Directors on the State of the Corporation's Affairs for the Year Ending
December 31 2010
Minimal Disclosure Required for Value Estimates and in their Regard, and Rules Pertaining to their Addition to Reports as per Securities Authority Guidelines in Accordance with Section 8b of the Securities Regulations (Periodic and Immediate Reports), 1970.
Assessment of the Total Value of the 777-200 747-400 Fleets a. Introduction
International Accounting Standard 36 establishes rules regarding the accounting treatment, presentation and disclosure required in the event of the impairment of assets.
The purpose of the standard is to establish procedures the corporation must implement in order to ensure that these assets are not presented in sums higher than their recoverable amount. An asset is presented in the Financial Statements at higher than its recoverable amount when its book value is higher than the sum received from the use or sale of the asset. In this case the asset has undergone depreciation and IAS 36 demands that the corporation recognize the loss from depreciation.
The following document presents the key points of the value estimate performed by El Al Israel Airlines Ltd. (hereinafter "El Al" or "The Company") in order to determine whether the depreciation of its 777-200 and 747-400 fleets (hereinafter "the Fleets") was to be recognized according to IAS 36, in accordance with Securities Authority directives.
This document was prepared in accordance with guidelines from the Securities Authority as per Section 8b of the Securities Regulations (Periodic and Immediate Reports), 1970, regarding minimal required disclosure for value assessments and in their regard and rules regarding their addition to reports.
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b. Specification and Identification of Asset Group
The asset group for which the test was conducted includes the 777-200 fleet which consists of 6 aircrafts owned by the Company and the 747-400 fleet which consists of 5 aircrafts owned by the Company.
c. Opinion Validity Date
March 2011. The value estimate was based on financial projections for 2010 and coming years.
d. Value Assessor
The value assessment was performed by El Al management.
e. Circumstances under which the IAS 36 Value Assessment was Conducted
The book value of the aircraft fleet is higher than its market value as appearing in price lists published by AVAC – the Aircraft Value Analysis Company and Airclaims - ASCEND World Wide.
Note that use of the market value of the aircraft on the basis of AVAC and Airclaims price lists is common practice among airlines around the world as well as among financing banks and has been used by El Al in its various commitments with banks.
IAS 36 states that a provision for impairment must be made when the book value of an asset exceeds its recoverable amount. A recoverable amount is calculated as the asset's net selling price or value in use, whichever is higher.
The net selling price is the sum that may be received from the sale of the asset in a good faith agreement between a willing buyer and a willing seller. The value in use of an asset is the current value of estimated future cash flow expected to derive from continuous use of the asset and its sale at the end of the period of use. The Company considers the market value of the assets as published by AVAC and Airclaims as representing the net sales price of its assets. As of this value assessment, the Company has examined the value in use of the aircraft in its possession and in its service, the depreciated value of which in the Company's December 31 2010 Financial Statements is greater than their selling price.
As of this value assessment, the selling price of the 777-200 fleet amounts to a total of $464 million, compared to the depreciated retained cost in the books of
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those aircraft as of December 31 2010, which amounts to a total of $538 million.
The selling price of the 747-400 fleet amounts to a total of $158 million, compared to the depreciated retained cost in the books of those aircraft as of December 31 2010, which totals $243 million.
f. Assessment Method
The value assessment was conducted according to the discounted cash flow method. According to this approach, assessed cash flows expected for the Company from the use of the aircraft fleet were discounted. The following are key assumptions used in calculating value:
Useful life: for the 777-200 fleet - 12 years of activity (and sale of the aircraft at net selling price at the end of the 12 year period), for the 747-400 fleet - 7 years of
activity (and sale of the aircraft at net selling price at the end of the 7 year period).
Cash flow expected from activity: management calculated that the projected cash flow from the operation of the 777-200 aircraft fleet will amount to $98 million in 2010, and the cash flow from the operation of the 747-400 aircraft fleet will amount to $107 million. This cash flow was calculated based on revenues from the aircraft fleet less commissions and variable expenses that may be assigned to the fleet in question and less fixed cash flow expenses such as security and maintenance expenses that may be allocated relative to the cost of these aircrafts'
operation.
Residual value at the end of useful life (meaning after 12 years for the 777-200 fleet and 7 years for the 747-400 fleet): calculated based on AVAC and Airclaims projections and totaling $205 million for the 777-200 fleet and $74 million for the
747-400 fleet (non-discounted values).
Growth rate: no real future growth in the Company's activities from the aircraft
fleet in question was taken into account, and it is based on 2010 performance.
Discount rate: an 8% discount rate was assumed. According to Company Management's estimates, this discount rate adequately reflects the capital price
component for the Company.
The load factor for coming years in these aircraft was assumed at a fixed rate as in
the 2010 performance.
The current tax rate expected for the Company for the coming 7-12 year period is
zero.
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The Company assumes that the aircraft in question shall be used as passenger
aircraft for the next 7-12 years.
The Company did not assume the need to make any unexpected investments in
these aircraft in order to permit their continued use.
g. Value set using the Discounted Cash Flow Method for the 777-200 fleet (in millions of dollars):
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Total Total discounted 94 87 81 75 69 64 59 55 51 47 43 40 765 cash flow Total discounted residual 81 81 value (after 12 years)
Total value in use of the above aircraft fleet based on the cash flow discount method: $846 million.
The following is a sensitivity analysis of the value of these aircraft for changes in discount price, changes in jet fuel prices and for changes in the contribution of cash which according to the Company constitute key elements that may alter projections of value in use:
Discount 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% Rate
Contribution Yearly
In Millions of Dollars
85 835 812 789 768 747 727 708 690
90 879 854 830 808 786 765 746 727
95 922 896 871 848 825 804 783 763
98 945 918 893 869 846 824 803 782
105 1,008 980 954 928 904 880 858 836
110 1,051 1,022 995 968 943 919 895 873
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Fuel price sensitivity analysis, use of the asset across 12 years:
Difference of Reduced NPV Yearly Fuel Price NPV Vs. Value Contribution Reduced Value (Cent per Gallon)
In Millions of Dollars
455 538 993 112 222
397 538 935 105 234
308 538 846 98 247
281 538 819 91 259
223 538 761 84 271
h. Value set using the Discounted Cash Flow Method for the 747-400 fleet (in millions of dollars):
2011 2012 2013 2014 2015 2016 2017 Total
Total discounted 103 95 88 82 76 70 64 578 cash flow
Total discounted 43 43 scrap value (after 7 years)
Total value in use of the above aircraft fleet based on the cash flow capitalization method: $621 million.
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The following is a sensitivity analysis of the value of these aircraft for changes in discount price, changes in jet fuel prices and for changes in the contribution of cash which according to the Company constitute key elements that may alter projections of value in use:
Discount 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% Rate
Contribution Yearly
In Millions of Dollars
90 567 557 548 539 530 522 513 505
95 595 585 576 566 557 548 540 531
100 624 614 604 594 584 575 566 557
107 663 652 642 631 621 611 602 593
110 681 670 659 649 638 628 619 609
115 710 699 687 676 665 655 645 635
Fuel price sensitivity analysis, use of the asset across 7 years:
Difference of Reduced NPV Yearly Fuel Price
NPV Vs. Value Contribution Reduced Value (Cent per Gallon)
In Millions of Dollars
459 243 702 122 220
419 243 662 114 232
378 243 621 107 244
338 243 581 99 256
298 243 541 92 268
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i. Summary
The following table presents the summarized value assessment as of December 31 2010 for the 777-200 fleet:
Recoverable sum calculation
Net Selling Price Value in Use Recoverable Amount - (Net Selling Price) (Value in use) Whichever is Higher For El Al for El Al
In Millions of Dollars
464 846 846
Should Impairment be listed in the Books?
The Aircrafts' Depreciated The Recoverable Amount Should Impairment Retained Cost as of of the Same Aircraft to El be Listed in the December 31 2010 Al, as of December 31 Books? 2010
In Millions of Dollars
538 846 No
The following table presents the summarized value assessment as of December 31 2010 for the 747-400 fleet:
Recoverable sum calculation
Net Selling Price Value in Use Recoverable Amount - (Net Selling Price) (Value in use) Whichever is Higher for El Al for El Al
In Millions of Dollars
158 621 621
b-54 Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Should Impairment be listed in the Books?
The Aircrafts' Depreciated The Recoverable Amount Should Impairment Retained Cost of the Same Aircraft to El be Listed in the as of December 31 2010 Al, as of December 31 Books? 2010
In Millions of Dollars
243 621 No
This value assessment is accurate on the date of its preparation and is based upon monetary details for 2010 and on projected income and expenses for the next 7-12 years. Changes in the projected assessments detailed above may alter the value assessment and the Company may subsequently be required to perform impairment.
b-55 Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
______
2010 ANNUAL REPORT
CHAPTER C 2010 FINANCIAL STATEMENTS
Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
EL AL ISRAEL AIRLINES LIMITED
Consolidated Financial Statements
For 2010
Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
EL AL ISRAEL AIRLINES LIMITED
2010 CONSOLIDATED FINACIAL STATEMENTS
C o n t e n t s
Page
Independent Auditors' Report C-3-C-4
Financial Statements
Consolidated Balance Sheets C-5-C-6
Consolidated Statements of Operations C-7
Consolidated Statements of Comprehensive Income C-8
Consolidated Statement of Changes in Shareholders' Equity C-9 - C-10
Consolidated Statement of Cash Flow C-11 - C-12
Notes to the Consolidated Financial Statements C-13 - C-119
Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Independent Auditors' Report to Shareholders of El Al Israel Airlines Ltd. On the Matter of the Auditing of Components of Internal Controls of Financial Reporting In Accordance with Section 9.b.(c) of the Securities Regulations (Periodic and Immediate Reports), 1970
We have inspected components of the internal controls of the financial reporting of El Al Israel Airlines Ltd. and its subsidiaries (hereinafter “the Company”) as of December 31 2010. These control components have been set as explained in the following paragraph. The Company's Board of Directors and management are responsible for maintaining effective internal controls over financial reporting, and for evaluating the effectiveness of the internal controls over financial reporting which is included in the periodic report for the date in question. Our responsibility is to express our opinion on the internal control elements of the Company’s financial reporting, based on our audit.
Components of internal control of financial reporting inspected by us were determined according to Audit Standard 104 of the Institute of Certified Public Accountants in Israel “Inspection of Components of Internal Controls for Financial Reporting” (hereinafter “Audit Standard 104”). These components are: (1) organization-level controls, including controls of the process of preparing and closing financial reporting and general controls of information systems; (2) controls of passenger revenues from the sale of flight tickets (with the exception of subsidiaries); (3) controls of frequent flyer club; (4) controls for fixed assets – aircraft, engines and spare parts; (5) controls for derivative financial instruments; (6) controls for agent commission expenses (Israeli branch); controls for fuel expenses; (8) controls for salary expenses for employees in Israel (with the exception of senior and very senior employees); (9) controls for actuary calculations for Israeli employees (with the exception of senior and very senior employees) (all of the above together are referred to as the “Audited Control Components”).
We have conducted our audit in accordance with Audit Standard 104. According to this standard, we were required to plan the audit and carry it out with the aim of identifying the inspected control components and achieve a reasonable level of certainty as to whether these control components were upheld effectively in all material aspects. Our audit included achieving an understanding of the internal controls for financial reporting, evaluation of the risk of the presence of any material weakness in the inspected control components, as well as testing and evaluating those control components based on the evaluated risk. Our audit, regarding those control components, also included additional procedures that we believed to be necessary under the circumstances. Our audit referred solely to the audited control components, unlike an internal audit on all processes material to financial reporting, and therefore our opinion refers to the audited control components only. Furthermore, our audit did not refer to mutual influences between audited and unaudited control components and therefore, our opinion does not bring such negative impacts into account. We believe that our audit and the reports of the other CPAs provide an appropriate basis for our opinion in the context described above.
Due to their understandable limitations, internal controls over financial reporting in general and components thereof in particular, may fail to prevent or discover misrepresentation. Likewise, conclusions regarding the future on the basis of any present effectiveness assessment may be exposed to the risk that the controls become inappropriate due to changes in circumstances or that the application of the policy or the procedures changes to the worse.
A material weakness is a failure, or a combination of failures, in the internal controls of financial reporting, to the degree that a reasonable chance exists that material misrepresentation in the Company’s yearly or quarterly financial statements is not prevented or discovered in a timely manner.
The following material weakness in the audited control components were identified and had been included in the Board of Directors’ and management’s estimates: The company did not fulfill an effective control in the processes relating to approval and disclosure of the service and employment terms of the outgoing CEO, Mr. Haim Romano and other executives in the company. These should be approved by the authorized institutions as required according to the relevant law.
The material weakness in question was taken into account when setting the nature, timing and scope of auditing procedures applied in our auditing of the Company's Consolidated Financial Statements for December 31 2010 and the year ending that date, and this report does not impact our report on the Financial Statements in question.
In our opinion, due to the influence of the material weakness identified above on the achievement of the control goals, the Company has not upheld in an effective manner its audited control components as of December 31 2010. We have also conducted an audit, in accordance with generally accepted Israeli auditing standards, the Company’s Consolidated Financial Statements for December 31 2010 and 2009 and for each of the three years of the period ending December 31 2010 and our report, published March 22 2011, includes our unreserved opinion of those Financial Statements based on our audit and on the reports of the other auditing accountants.
Brightman Almagor Zohar & Co. Certified Public Accountants
Tel Aviv, March 30, 2011
- C 3 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
INDEPENDENT AUDITORS' REPORT TO THE SHAREHOLDERS OF El Al Israel Airlines Ltd.
We have audited the attached balance sheets of El Al Israel Airlines Ltd. ("the Company") as of December 31 2010 and 2009 and the Consolidated Balance Sheets as of those dates, and the Statements of Operations, Statement of Comprehensive Income, Changes in Shareholders' Equity and Cash Flow for each of the three years in the period ended December 31, 2010. The Company's Board of Directors and management are responsible for these Financial Statements. Our responsibility is to express our opinion of these Financial Statements on the basis of our audit.
We did not audit the financial statements of consolidated subsidiaries, the assets of which included in the consolidation represent approximately 1.3% and 1.3 of total consolidated assets as of December 31 2010 and 2009, and whose revenues included in consolidation constitute 1.0%, 1.1% and 1.0% of total consolidated revenues for the years ending December 31 2010, 2009 and 2008, respectively. The Financial Statements of said companies have been audited by other CPAs the reports of whom have been provided to us and our opinion, inasmuch as it refers to sums consolidated for the aforementioned companies, is based on the reports by these other CPAs.
We have conducted our audit according to generally accepted Israeli auditing standards, including regulations included in the Accountants’ Regulations (The Accountant’s Method of Operation), 1973. Those Standards require that we plan and perform the audit with the aim of obtaining reasonable assurance that the Financial Statements are free of material misrepresentations. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. The audit also contains an examination of the accounting rules implemented and of the material estimates made by the Company’s Board of Directors and management, as well as an evaluation of the propriety of presentation on the Financial Statements as a whole. We believe that our audit and the reports of the other CPAs provide an appropriate basis for our opinion.
In our opinion, based on our audits and the reports of other accountants, the Financial Statements referred to above adequately reflect, in all material respects, the financial position of the Company and its subsidiaries as of December 31, 2010 and 2009 and the results of their operations, changes to their equity and their cash flows for each of the three years in the period ending December 31, 2010, in accordance with the International Financial Reporting Standards ("IFRS") and with the provisions of the Israeli Securities Regulations (Yearly Financial Statements), 2010.
We have also audited, in accordance with Audit Standard 104 of the Institute of Certified Public Accountants in Israel “Inspection of Components of Internal Controls for Financial Reporting”, components of internal controls of the Company’s financial reporting as of December 31 2010, and our March 22 2011 report includes an negative opinion regarding those components due to the existence of a material weakness.
Brightman Almagor Zohar & Co. Certified Public Accountants
Tel Aviv, March 22, 2011
- C 4 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd. Consolidated Balance Sheets
As of December 31 Note 2 0 10 2 0 0 9 Thousands of Thousands of Dollars Dollars
Assets
Current Assets
Cash and cash equivalents 5a 111,002 106,687
Short term deposits 6 63,565 7,933
Restricted deposits 5b - 7,003 Trade receivables 8 132,960 112,086 Other accounts receivables 9 20,880 16,155 Derivative financial instruments 7,31 42,190 11,206 Prepaid expenses 10 26,995 * 20,395 Inventories 11 18,756 21,947 Total current assets 416,348 303,412
Non-Current Assets Bank deposits 13 1,869 1,839 Investment in affiliated companies 15b 693 648 Investments in other companies 14 11,552 1,357 Derivative financial instruments 7,31 4,291 2,255 Fixed assets, net 16 1,231,687 1,312,930 Intangible assets, net 17 7,844 7,504 Prepaid expenses 10 8,121 * 7,056 38,799 34,501 Assets due to employee benefits 23 Total non-current assets 1,304,856 1,368,090
Total assets 1,721,204 1,671,502
(*) restated - see Note 2aa
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 5 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd. Consolidated Balance Sheets
As of December 31 Note 2 0 10 2 0 0 9 Thousands of Thousands of Dollars Dollars Liabilities and Equity
Current Liabilities Borrowings and current maturities 18 147,587 106,016 Trade payables 19 157,912 128,970 Other payables 20 49,625 54,444 Provisions 27 44,939 57,217 Derivative financial instruments 25,31 2,329 55,643 Employee benefit obligations 23 98,712 81,379 Unearned revenues 24 231,204 204,444 Total current liabilities 732,308 688,113
Non-Current Liabilities Loans from financial institutions 22 561,084 704,194 Employee benefit obligations 23 65,590 65,835 Derivative financial instruments 25,31 19,739 20,135 Other payables 20 10,700 13,318 Deferred taxes 28 32,792 5,313 Unearned revenues 24 51,467 50,813 Total non-current liabilities 741,372 859,608
Total liabilities 1,473,680 1,547,721
Shareholders' Equity 30 Share capital 155,012 155,012 Share premium 28,007 28,007 Capital reserve from transactions with a former controlling shareholder 237,122 237,122 Capital reserve in respect of share-based payment 7,198 6,414 Capital reserve in respect of cash flow hedging 35,082 (30,822) Accumulated loss (214,897) (271,952) Total shareholders' equity 247,524 123,781
Total liabilities and equity 1,721,204 1,671,502
Amikam Cohen Elyezer Shkedi Nissim Malki Chairman of the Board of Directors Chief Executive Officer Chief Financial Officer
Certification date of Financial Statements: Ben-Gurion Airport, March 22, 2011.
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 6 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding El Al Israel Airlines Ltd. Consolidated Statements of Operations
For the Year Ending December 31 Note 2 0 10 2 0 0 9 2 0 0 8 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Operating revenues 32a 1,972,239 1,655,833 2,096,326 Operating expenses 32b (1,584,557) (1,444,250) (1,776,329)
Gross profit 387,682 211,583 319,997
Selling expenses 32c (214,755 ) (182,962) (227,573) General and administrative expenses 32d (96,153 ) (88,562) (97,103) Other operating revenues (expenses), net 32e 11,269 (15,027) (975)
(299,639) (286,551) (325,651)
Operating profit (loss) before 88,043 (74,968) (5,654) financing
Financing expenses 33 (35,911 ) (30,297) (61,566) Financing income 34 10,849 3,999 16,969 Financing expenses, net (25,062) (26,298) (44,597)
Company's equity in earnings of affiliates, net of tax 45 442 543
Income (loss) before income taxes 63,026 (100,824) (49,708)
Tax benefit (income taxes) 28 (5,971) 24,524 7,801
Profit (loss) for the year 57,055 (76,300) (41,907)
Profit (loss) per 1 NIS NV ordinary share. (In USD) Basic profit (loss) per share 35 0.12 (0.15) (0.08)
Diluted profit (loss) per share 35 0.11 (0.15) (0.08)
Weighted average numbers of shares (in thousands) used in the calculation of profit (loss) per share Basic 495,719 495,719 495,719 Diluted 496,793 495,719 495,719
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 7 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding El Al Israel Airlines Ltd. Consolidated Statement of Comprehensive Income
For the Year Ending December 31 2 0 10 2 0 0 9 2 0 0 8 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Profit (loss) for the year 57,055 (76,300) (41,907)
Other comprehensive income (loss)
Profit (loss) in respect of cash flow hedging, net of tax 65,904 80,783 (119,946 )
Other comprehensive income (loss) for the year, net of tax 65,904 80,783 (119,946)
Total comprehensive income (loss) for the year 122,959 4,483 (161,853)
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 8 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding El Al Israel Airlines Ltd. Consolidated Statement of Changes in Shareholders' Equity
For the Year Ending December 31 2008 Capital Reserve from Capital Transa- Reserve Capital ctions with in Reserve a Former Respect in Respect Controlling of Share- of Cash Share Share Share- Based Flow Accumulated Capital Premium holder Payment Hedging Loss Total Thousands of Dollars Balance as of January 1, 2008 155,012 28,007 237,122 4,464 8,341 (153,699) 279,247
Yearly loss (41,907 ) (41,907) Other comprehensive loss for the year (119,946) (119,946) Total comprehensive loss for the year - - - - (119,946) (41,907) (161,853)
Adjustments due to dividends distributed - - - - - (46) (46) Share-based payment - - - 1,316 - - 1,316 Total transactions with parent company shareholders pursuant to their position as shareholders - - - 1,316 - (46) 1,270
Total equity as of December 31 2008 155,012 28,007 237,122 5,780 (111,605) (195,652) 118,664
For the Year Ending December 31 2009 Capital Capital Reserve Reserve Capital from Trans- in Reserve actions with Respect in Respect a Former of Share- of Cash Share Share Controlling Based Flow Accumulated Capital Premium Shareholder Payment Hedging Loss Total Thousands of Dollars Balance as of January 1 2009 155,012 28,007 237,122 5,780 (111,605) (195,652) 118,664
Yearly loss (76,300 ) (76,300) Other comprehensive income for the year 80,783 80,783 Total comprehensive income for the year - - - - 80,783 (76,300) 4,483
Share-based payment - - - 634 - - 634 Total transactions with parent company shareholders pursuant to their position as shareholders - - - 634 - - 634
Total shareholders' equity as of December 31 2009 155,012 28,007 237,122 6,414 (30,822) (271,952) 123,781
The accompanying Notes constitute an integral part of the Consolidated Financial Statements . - C 9 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd. Consolidated Statement of Changes in Shareholders' Equity
For the Year Ending December 31 2010 Capital Capital Reserve Reserve Capital from Trans- in Reserve actions with Respect in Respect a Former of Share- of Cash Share Share Controlling Based Flow Accumulated Capital Premium Shareholder Payment Hedging Loss Total Thousands of Dollars
Balance as of January 1 2010 155,012 28,007 237,122 6,414 (30,822) (271,952) 123,781
Yearly profit 57,055 57,055 Other comprehensive income for the year 65,904 65,904 Total comprehensive income for the year - - - - 65,904 57,055 122,959
Share-based payment - - - 784 - - 784 Total transactions with parent company shareholders pursuant to their position as shareholders - - - 784 - - 784
Total shareholders' equity as of December 31 2010 155,012 28,007 237,122 7,198 35,082 (214,897) 247,524
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 10 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd. Consolidated Statement of Cash Flow
For the Year Ending December 31 2 0 10 2 0 0 9 2 0 0 8 Thousands Thousands of Thousands of Dollars Dollars of Dollars
Cash Flows from Operating Activities Net profit (loss) for the year 57,055 (76,300 ) (41,907) Appendix A - Adjustments required for presentation of cash flow from operating activities 146,236 98,699 160,782
Cash deriving from operating activities, net 203,291 22,399 118,875
Cash Flow for Investment Operations Acquisition of fixed assets (including general engine overhauls and payment on account of aircraft) (46,548 ) (178,679) (159,580) Proceeds from the realization of fixed assets 2,802 22,803 9,676 Investment in intangible assets (3,054 ) (1,955) (5,078) Realization (investment) in restricted deposits 7,003 145,966 (152,969 ) Decrease (increase) in short-term deposits, net (55,632 ) (112) 172,812 Investment in deposits for service providers and long-term (157 ) (176) (318) Repayment of deposits for service providers and long-term 354 727 360 Decrease in investments and loans to investee companies, net - 1,229 - Cash yield from the sale of affiliate - 571 -
Cash used for investment activities, net (95,232) (9,626) (135,097)
Cash Flows from (for) Financing Activities Receipt of long-term loans from financial institutions - 113,259 36,000 Repayment of long-term loans from financial institutions (77,804 ) (74,615) (64,911) Receipt of other long-term loans 2,568 - - Repayment of other long-term loans (1,596 ) (254) (385) Payment for loan raising costs - (7,159) - Increase (decrease) in short-term credit, net (26,912 ) 12,083 12,501 Dividends paid - - (3,053)
Cash deriving from (used for) financing activities, net (103,744) 43,314 (19,848)
Increase (decrease) in cash and cash equivalents 4,315 56,087 (36,070 )
Balance of cash and cash equivalents at the beginning of the year 106,687 50,600 86,670
Balance of cash and cash equivalents at the end of the year 111,002 106,687 50,600
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 11 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd. Consolidated Statement of Cash Flow
For the Year Ending December 31 2 0 10 2 0 0 9 2 0 0 8 Thousands of Thousands Thousands Dollars of Dollars of Dollars Appendix A -
Income and expenses not involving cash flows: Depreciation and amortization (including disposal of accessories, disused components and consumables used and impairment of fixed and intangible assets) 130,580 160,987 131,098 Adjustment of value of deposits for trade payables and long-term (98 ) 7 127 Share of earnings of affiliated companies, less dividends received, net (45 ) (284) (468) Deferred taxes, net 6,098 (24,604 ) (6,989) Decrease in liabilities in respect of employee benefits and in provisions (495 ) (18,754) (17,555) Net capital gains from realized fixed assets (672 ) (582) (7,418) Benefit value of employee share option program 784 634 1,316 Loss (gain) from adjustment of fair value of derivatives recognized in the statement of operations 555 (23,542 ) 65,087 Decrease in other long-term liabilities - - (168) Profit from shares and options received for no return (11,145 ) - - Revaluation of shares and options received for no return 821 - -
Changes in asset and liability items: Decrease (increase) in trade receivables (20,874 ) (6,040) 37,571 Decrease (increase) in other accounts receivable (4,725 ) 4,110 (1,269 ) Decrease (increase) in prepaid expenses (7,665 ) 2,001 6,840 Decrease (increase) in inventories 3,191 (10,475 ) 4,509 Increase (decrease) in trade payables 28,942 (1,923 ) (33,230) Increase (decrease) in other payables (6,430 ) 12,252 (4,856 ) Increase (decrease) in unearned revenues 27,414 4,912 (13,813)
146,236 98,699 160,782
Appendix B – Payment (Receipt) of Interest, Taxes and Dividends, Classified Under Cash Flow from Operating Activities
Interest payments 25,138 28,283 35,759
Interest receipts (2,817) (1,072) (10,680)
Tax payments – advances in respect of extraneous expenses 334 203 235
Dividend receipts (20) (159) (76)
The accompanying Notes constitute an integral part of the Consolidated Financial Statements .
- C 12 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
El Al Israel Airlines Ltd. Notes to the Consolidated Financial Statements
Note 1 - General
a. General Description of the Company and its Activities:
EL AL Israel Airlines Ltd (hereafter-"the Company") was incorporated on November 15, 1948 as a state company. In 2003 the Company's stock was first offered to the public. The Company is the Israeli designated carrier on most routes to and from Israel, other than a number of routes on which other Israeli carriers were granted the status of designated carriers.
The Company is primarily engaged in the transport of passengers and cargo, including luggage and mail, on scheduled flights and charter flights between Israel and foreign countries. Passenger transport on charter flights is carried out mainly by Sun D'Or International Airlines Ltd (hereafter - "Sun D'Or"), a wholly owned subsidiary of the Company.
The Company is also engaged in leasing flight equipment, providing luggage handling and maintenance services at its home airport, sale of duty-free products and - through investees - in related activities, mainly production and supply of airline meals and management of several travel agencies in Israel and abroad.
Starting June 2004, EL AL is defined as a “mixed company” pursuant to the Government Corporations Law, 1975, which defines a “mixed company” as one that is not a government corporation, with half or less than half of the voting rights in its General Meetings or the right to appoint half or less than half of its directors, in the hands of the State.
As of December 31 2010 and 2009, the State holds only 1.1% of the ownership and voting rights in the Company, in addition to the rights derived from the Special State Share it holds.
b. Definitions:
The Company - EL AL Israel Airlines Ltd.
The Group - The Company and its investee companies.
Related parties - As defined in IAS 24.
Interested parties - As defined in the Securities Law, 1968 and regulations thereof.
Controlling shareholders - As defined in Securities Regulations (Yearly Financial Statements), 2009.
CPI - The Consumer Price Index, as published by the Central Bureau of Statistics.
USD - US Dollar.
Consolidated companies - Companies in which the Company has control (as defined in IAS 27), directly or indirectly, whose financial statements are wholly consolidated with the Company's financial statements.
Affiliated companies - Companies in which the Company has material influence.
Investee companies - Consolidated and affiliated companies.
Other companies - Companies owned by the Group in which the latter has no control, joint control or material influence.
- C 13 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
c. Failure to Include Separate Financial Information:
In accordance with Regulation 4 of the Periodic and Immediate Reports Regulations, the Company did not include in its periodic report for the year ending December 31 2010 separate financial information as per Regulation 9.c of the regulations in question. The reason due to which no separate information was included was the negligible impact the financial statements of the investee companies have on the Consolidated Financial Statements. The parameters used by the Company in order to establish the impact in question are: revenues, profits and cash flows from operating activities of up to 5% of all assets, revenues, profits and cash flows from operating activities in the consolidated statements – accordingly, ignoring the impact of uncommon exceptional occurrences. For information regarding transactions and commitments between the Company and its consolidated companies see Note 40.
Note 2 - Principal Accounting Policies
a. Statement Regarding the Implementation of International Financial Reporting Standards (IFRS)
The Group's consolidated financial statements have been compiled in accordance with International Financial Reporting Standards (IFRS) and clarifications thereto issued by the International Accounting Standards Board (IASB). The principal accounting policies listed below have been consistently applied to all reported periods presented in these Consolidated Financial Statements, except for changes to accounting policies due to application of standards, revised standards and interpretations that have become effective as of the balance sheet date, or applied by way of early adoption, as detailed in Note 3 below.
b. The Financial Statements have been prepared in accordance with provisions of the Securities Regulations (Annual Financial Statements), 2010 (hereinafter “Financial Statement Regulations").
c. The Company's operational turnover period is 12 months.
d. Basis of Preparation of Financial Statements:
These Financial Statements have been prepared on the basis of historical cost except for the following:
. The following assets and liabilities, which are measured at fair value: financial instruments measured at fair value via gain/loss, derivative financial instruments. . Inventory, presented at cost or net realization value, whichever is lower. . Fixed assets and intangible assets, presented at cost net of accumulated depreciation and amortization or at its recoverable amount, whichever is lower. . Liabilities in respect of employee benefits, as set forth in Note 23
e. Foreign Currency:
(1) Functional and Presentation Currency
The financial statements of each Group company are compiled in the currency of the major economic environment in which it operates (hereinafter: "the Functional Currency"). For the purpose of financial statement consolidation, the financial standing and results of each Group company are presented in USD, which is the Company's functional currency. The Company's Consolidated Financial Statements are presented in USD. For exchange rates and changes thereto during the periods presented, see Note 2bb.
(2) Translation of Transactions in Currencies other than the Functional Currency
When compiling the financial statements of each Group company, transactions executed in currencies other than said company's functional currency (hereinafter: "Foreign Currency") are recorded at the exchange rates effective as of the transaction date. Upon each balance sheet date, - C 14 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
monetary items denominated in foreign currency are translated using the exchange rate effective as of that date; non-monetary items measured at fair value and denominated in foreign currency are translated using the exchange rate effective as of the date on which fair value is determined; non- monetary items measured at historical cost are translated using the exchange rate effective as of the date of the transaction involving the non-monetary item.
(3) Recognition of Exchange Rate Differentials
Exchange rate differentials are recognized in the statement of operations in the period in which they were generated, with the exception of exchange rate differentials for transactions intended to hedge certain foreign currency risks; see Note 2o.
f. Consolidated Financial Statements:
The Group's Consolidated Financial Statements include the financial statements of the Company and of entities directly or indirectly controlled by the Company. Control exists whenever the Company has the power to direct the financial and operational policies of an investee company in order to derive benefits from its operations.
For the sake of consolidation, all inter-company transactions, balances, revenues and expenses are fully eliminated.
g. Investments in Affiliated Companies
An affiliated company is an entity in which the Group has material influence and which is not a consolidated company. Material influence is the power to participate in decision making with regard to financial and operational policies of the affiliated company, which does not constitute control or joint control of said policies. The results, assets and liabilities of affiliated companies are included in the Company's Consolidated Financial Statements based on the book value method. Gain or loss generated from transactions between the Company or a subsidiary and an affiliated company of the Group is eliminated based on the Group's share of rights in said affiliated company.
h. Cash and Cash Equivalents:
Cash and cash equivalents include bank deposits available for immediate withdrawal as well as limited term deposits the use of which is unrestricted and whose term to maturity, at the time of investment, is no greater than three months. Deposits the redemption date of which, on the date of investment in them, exceeds three months and is no greater than one year are classified under short term deposits. Deposits for which limitations exist regarding their use are classified under restricted deposits.
i. Inventories
Inventory is presented at the lower of its cost and net realization value. The cost of inventory includes all purchasing costs and other cost incurred in getting the inventory to its current location and status. Net realization value represents the estimated sales price over the regular course of business less estimated completion costs and estimated costs required to conduct the sale. Cost is determined using the weighted moving average method.
- C 15 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
j. Fixed Assets:
(1) General:
Fixed assets are tangible items held for use in providing services or for leasing to others which are expected to be used for more than one period.
The Company presents its fixed asset items using the following cost model: Fixed asset items are presented in the balance sheet at cost, net of accumulated amortization and net of accumulated impairment, if any. The cost includes the cost of acquiring the asset and also the costs that are attributable directly to bringing asset to the location and state required for the purpose intended by management. On the matter of testing the amortization of fixed assets see Note 2l.
(2) Amortization of Fixed Assets:
Fixed assets are amortized separately for each component of depreciable fixed asset item having a significant cost relative to the total item cost. Amortization is calculated systematically, using the straight line method over the expected useful life of the item components, starting on the date on which the asset is ready for its intended use, accounting for the expected residual value at the end of its useful life. Assets under a financial lease are amortized over their expected useful life on equivalent basis of owned assets, or over the term of the lease, if shorter.
The cost of overhauling aircraft engines is recognized as an asset on the balance sheet, amortized over the period of economic benefit expected from said overhaul (based on estimated number of engine hours).
The residual values, depreciation method and useful life span of the asset are reviewed by Company management at the end of each financial year. Changes are treated as changes in estimates, on a prospective basis. Gain or loss generated from sale or obsolescence of an asset is determined by the difference between proceeds from its sale and its carrying amount, and is recognized in the statement of operations.
The cost of accessories and spare parts included with fixed assets is determined using the weighted moving average method. Accessories and spare parts attributed to a specific fleet are amortized over the average remaining life time of said fleet. Accessories and spare parts not attributed to a specific fleet are amortized according to the balance of the average life time of the Company's entire aircraft fleet. Accessories and spare parts with no movement or slow movement are included at depreciated values according to management estimate. Regarding the Company’s depreciation rates see Note 16.b.2
(3) Consecutive Costs:
The cost of replacing part of a fixed asset item capable of being reliably estimated is recognized as an increase in carrying amount upon creation, although future economic benefits attributed to the item are expected to flow to the entity. Regular maintenance costs are charged to the Statement of Operations upon creation.
k. Intangible Assets:
Rights for the use of security equipment are included at their cost to the Company, and are amortized using the straight line method based on the anticipated period of economic use, subject to impairment review. The life span estimate and amortization method are reviewed at the end of each fiscal year, with the impact of changes to the estimate treated on a prospective basis. Software is included at its cost to the Company and is amortized using the straight line method based on its expected period of economic use. - C 16 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
l. Impairment of Tangible and Intangible Assets:
At each balance sheet date, the Group evaluates the book value of its tangible and intangible assets, excluding inventories, with the aim of establishing whether there are any signs pointing to erosion in the value these assets. If any such indications exist, the asset's recoverable amount is estimated in order to determine the impairment loss, if any. If the recoverable amount for a single asset cannot be estimated, the Group estimates the recoverable amount of the cash-producing unit to which the asset belongs. The recoverable amount is the assets sales price less cost of sale or its value in use, whichever is higher. When estimating the value in use, future cash flows are discounted to their present value using a pre-tax discount rate which reflects the current market estimates for time value of money and for asset-specific risks for which the future cash flow estimate has not been adjusted. If the recoverable amount of an asset (or for a cash-generating unit) is estimated to be lower than its carrying amount, the carrying amount of the asset (or of the cash-generating unit) is depreciated down to its recoverable amount. Impairment loss is immediately recognized as an expense in the Statement of Operations. Company management believes that recoverable amounts for aircraft should be studied relative to their depreciated cost after grouping aircraft fleets, and that it is incorrect to review the recoverable amount of each aircraft separately relative to its depreciated cost. The Company, having grouped the aircraft fleets as set forth above, has determined that for each aircraft group, the recoverable amount exceeds the depreciated cost of said aircraft group upon that date. When impairment loss recognized in previous periods is cancelled, the book value of the asset (or of the cash-generating unit) is increased back to the updated estimated recoverable value, but not more that the book value of the asset (or the cash-generating unit) that would have existed if an impairment loss form had not been recognized in for it in previous periods. Cancellation of impairment loss is recognized immediately to gain/loss, unless the relevant asset is measured according to a revaluation model. In such a case the cancellation of impairment loss is charged directly to gain/loss up to the sum at which the impairment loss recognized in the Statement of Operations in previous periods is derecognized, and the balance of the increase, if any, is charged to Other Comprehensive Income.
m. Financial Assets:
(1) General
Financial assets are recognized in the Group balance sheet when the Group becomes party to contractual terms of said instrument.
Investment in financial assets is initially recognized at fair value, plus transaction cost, except for financial assets recognized at fair value in the statement of operations, which are first recognized at fair value.
The Group's financial assets are categorized according to categories detailed below. This categorization depends on the nature and objective of the financial asset and is determined upon initial recognition of said financial assets: . Financial assets measured at fair value via gain/loss; . Financial assets and depreciated cost.
Regarding the influence of the early implementation of IFRS 9 “Financial Instruments” on the Company, see Note 3a. Regarding the influence of the revision to IAS 39 “Financial Instruments: Recognition and Measurement”, see Note 3b. Regarding the revision to IFRS 7 "Financial Instruments: Disclosures", see Note 3c.
A financial asset is a “capital instrument” when it constitutes a non-derivative instrument meeting the definition of “capital” as far as the issuing body is concerned. The balance of non-derivative financial instruments is “debt instruments”.
- C 17 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
(2) Financial Assets Measured at Depreciated Cost
The Group's financial assets in this category include trade receivables, deposits and other accounts receivable at fixed or fixable installments which have no quote on an active market. Loans and accounts receivable are measured at depreciated cost using the effective interest method, net of any impairment. Interest revenues are recognized using the effective interest method, except for short- term trade receivables and other accounts receivable – when interest amounts to be recognized in respect there of are not material.
The effective interest method is the method for calculating the depreciated cost of a debt instrument, as well as for the allocation of interest income across the instrument’s life span. The effective interest rate is the rate that precisely capitalizes future projected cash flow (including commissions, transaction costs and so on), throughout the debt instrument’s life span, or (when appropriate) a shorter period, to the current value of the instrument upon first recognition.
(3) Financial Assets Measured at Fair Value in the Statement of Operations
Financial assets are classified as "financial assets measured at fair value in the statement of operations" when such assets are held for trading or when they are designated as financial assets measured at fair value in the statement of operations.
A financial asset is classified as held for trade if it is a derivative neither designated nor effective as a hedging instrument.
The Group's financial assets under this category include derivative instruments not intended for use as hedging instruments, or which are not effective as such. These derivatives include certain derivatives based on the price of jet fuel, on interest rates and on exchange rates which are not designated as hedging instruments.
Financial assets measured at fair value in the statement of operations are presented at fair value. Any gain or loss due to change in fair value, including due to exchange rates, is recognized in the statement of operations in the period in which the change has occurred.
(4) Impairment of Financial Assets
Financial assets, except for those classified as financial assets measured at fair value in the Statement of Operations, are reviewed for indications of impairment upon each balance sheet date. Such impairment occurs when there is objective evidence that expected future cash flow from investment in such asset has been negatively impacted due to one or more events which have occurred subsequent to initial recognition of the financial asset.
Indications of impairment may include:
. Significant financial challenges to the debtor; . Failure to make current principal or interest payments; . Expectation that the debtor would become bankrupt or would re-structure their debt.
For financial assets presented at depreciated cost, impairment is recognized as equal to the difference between the financial asset's book value and the present value of future cash flow expected from them, discounted using their original effective interest rate.
If in a subsequent period, the loss due to impairment of a financial asset decreases, and said decrease is objectively related to an event occurring after recognition of impairment, then the impairment loss previously recognized is reversed, in whole or in part, in the statement of operations. Such reversal is limited in amount, so that the carrying amount of investment in the asset upon reversal of impairment loss would not exceed the depreciated cost of the asset as of that date - had no impairment been previously recognized.
- C 18 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
As for trade receivables: their carrying amount is decreased, if necessary, using a provision for doubtful debt. The provision is calculated specifically. When trade receivables are not collectable, they are written off against the provision account. Collection, in subsequent periods, of amounts previously written off is credited against the provision account. Changes in carrying amount of the provision account are recognized in the statement of operations.
n. Financial Liabilities and Equity Instruments Issued by the Group:
(1) Classification as Financial Liability or Equity Instrument
Non-derivative financial instruments are classified as a financial liability or as an equity instrument, based on the nature of their underlying contractual terms.
An equity instrument is any contract indicating a residual right to Group assets, after deduction of all Group liabilities. Equity instruments issued by the Company are stated at their issuance proceeds net of expenses directly related to issuance of said instruments.
Group financial liabilities are stated and measured based on the following classification:
. Financial liabilities measured at fair value in the statement of operations. . Other financial liabilities.
(2) Financial Liabilities at Fair Value via Gain/Loss
Group financial liabilities in this category include certain interest rate and exchange rate derivatives not designated as hedging instruments, as well as option warrants for the purchase of Company shares, as set forth above.
Financial liabilities measured at fair value in the Statement of Operations are stated at fair value. Any gain or loss due to change in fair value is recognized in the statement of operations. Transaction costs are charged to the Statement of Operations upon initial recognition.
Regarding the revision to IFRS 7 "Financial Instruments: Disclosures", see Note 3c.
(3) Other Financial Liabilities
Other financial liabilities include credit and loans, trade receivables and other accounts receivable. Such liabilities are initially recognized at fair value, net of transaction costs. Subsequent to initial recognition, other financial liabilities are measure at depreciated cost using the effective interest method.
The effective interest method is a method for calculating the net depreciated cost of a financial liability, and of the allocation of interest income or expenses over the relevant period. The effective interest rate is the rate that precisely discounts the projected flow of future cash receipts or payments over the course of the expected life span of the financial liability to its book value, or, as the case may be, for a shorter period.
(4) Detraction of Financial Liabilities
A financial liability is only removed when, and only when, it is paid up, meaning when the liability defined in the contract is defrayed, cancelled or expired.
Regarding the publication of IFRIC 19 "Removal of Financial Liabilities by Capital Instruments”, see Note 3c.
- C 19 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
o. Derivative Financial Instruments and Hedging Accounting:
(1) General
The Company employs a range of derivative financial instruments to manage exposure to changes in price of jet fuel, interest rates and foreign currency exchange rates. Derivative financial instruments are initially recognized at their fair value upon the contracting date and at each subsequent balance sheet date. Changes to the fair value of derivative financial instruments are generally recognized in the statement of operations. The timing of recognition in the statement of operations of changes in fair value of derivative financial instruments designated as hedging, when such hedging is effective and meets all conditions for qualifying it as a hedging relationship, depends on the nature and type of hedging, as set forth below.
The balance sheet classification of derivative financial instruments is determined based on the contractual term of the derivative financial instruments. If the remaining contractual term of the derivative is longer than 12 months, the derivative is stated as a non-current item on the balance sheet; if the remaining term is shorter than 12 months, the derivative is classified as a current item.
Regarding the revision to IFRS 7 "Financial Instruments: Disclosures", see Note 3c.
(2) Hedge Accounting
The Company applies cash flow hedge accounting, and to this end it has designated certain derivative financial instruments in respect of exposure to jet fuel prices and to interest rate changes.
In order to hedge jet fuel prices, the Company has entered into multiple transactions in respect of expected fuel purchases for terms of up to 2 years from the balance sheet date.
In order to reduce exposure to adjustable interest rates applicable to Company loans, the Company has entered into multiple contracts designated to fix interest rates. Interest hedging instruments used by the Company are aligned with repayment schedules of the loans they are designated to hedge in the related periods.
In order to reduce exposure do to the USD/NIS exchange rate, the Company conducted several transactions the purpose of which was to hedge several of the Company's expected NIS payroll payments.
The hedging relationships are documented by the Company upon contracting the hedging transaction. This documentation identifies the hedging instrument, hedged item, hedged risk, hedging strategy applied as well as a review of the fit of this strategy to overall Group policy for each hedge type. Furthermore, starting on the start date of the hedge relationship and throughout its existance, the Company documents the degree to which the hedging instrument is effective in offsetting exposure to changes in cash flow due to the hedged risk for the hedged item.
The effective portion of changes in value of financial instruments designated as cash flow hedges is immediately recognized in equity under "capital reserve in respect of cash flow hedging", and the non-effective portion is immediately recognized in the statement of operations.
Cash flow hedge accounting is discontinued when the hedging instrument expires, is sold or realized or when the hedging relationship no longer meets the minimum hedging conditions. Subsequent to discontinuation of hedge accounting, the amounts recognized in shareholders' equity are recognized in the statement of operations when the hedged item or the hedged anticipated transactions are recognized in the Statement of Operations.
- C 20 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
p. Revenue Recognition Base and Commission Attribution to Agents
(1) Revenues from sale of flight tickets are included as unearned revenues under current liabilities until the service is provided or up to 2 years from the sales date, whichever is earlier.
Air passenger revenues also include revenues where the service is provided by the Company, whereas flight tickets are sold by other airlines.
Furthermore, air passenger revenues also include revenues due to code sharing agreements with other airlines. In such cases, when the service is provided by the other airlines, while the sale is made by the Company, revenues are stated on net basis.
Regarding the frequent flyer programs, staring from its Financial Statements for the first quarter of 2009, the Group has applied IFRIC 13 – "customer loyalty programs". Accordingly, service sales transactions in which the Group grants its customers credit awards are treated as multi-component transactions, while allocating and the payment received from the customer to its different components based on the fair value of the credit awards. The proceeds charged to bonuses are recognized as income when the points are redeemed and the Company's obligation to provide the service is upheld.
(2) Air cargo revenues are charged as revenue in the Statement of Operations when the service is provided.
(3) Agent commissions referring to revenues not yet recognized are included in the Financial Statements under "pre-paid expenses", and will be recognized as selling expenses in the Statement of Operations concurrently with revenue recognition.
(4) Interest revenues are accumulated periodically, accounting for the principal to be repaid and using the effective interest method.
(5) Dividend revenues due to investments are recognized on the date entitlement for dividends are created.
q. Engine Maintenance and Refurbishment Expenses:
Engine maintenance and refurbishment expenses (not constituting an overhaul) are recognized in the Statement of Operations upon actual execution of the engine maintenance or refurbishment work.
In cases where the Company has entered into agreements of an insurance nature, the Company records expenses as specified in the insurance agreements, and the cost of refurbishment is incurred by the insurer.
r. Expenses for Securing Company Services:
Company contribution to government expenses for securing company services are recognized in the statement of operations when incurred, based on the Company's share of said expenses.
s. Leases
General
Lease agreements are classified as financial leases when terms of the contract transfer all material risk and rewards arising from ownership to the lessee. All other leases are classified as operational leases.
Financing Lease
In financing lease transactions in which the Group leases assets from a different entity, the Group recognizes the asset on the date of the beginning of the lease at its fair value or the current value of the minimum lease payments, whichever is lower. The commitment to provide minimum lease payments to - C 21 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
the lessor is presented in the Balance Sheet as a financial liability due to a lease. In consecutive periods, current payments are allocated due to the financial lease between the financing component and the liability component, in such a manner that a fixed interest rate is received calculated according to the balance of the liability. The part allocated to the financing component is charged to gain/loss.
Operating Lease
Rental fee expenses in respect of operational leases (primarily aircraft leases) are recognized based on the straight line method over the term of the lease. In lease agreements where no leasing fee, or a reduced leasing fee, is paid at the start of the leasing period and where other benefits are obtained from the lesser, the Company recognizes expenses based on the straight line method for the duration of the lease.
t. Provisions
(1) General
Provisions are recognized when the Group has a legal or implied obligation due to a past event, where use of reliably measurable economic resources is expected to discharge said obligation.
The amount recognized as a provision reflects management's best estimate of the amount required for settling the current obligation upon the balance sheet date, accounting for risk and uncertainty associated with said obligation. When the provision is measured using expected cash flows for settlement of the obligation, the carrying amount of the provision is the present value of expected cash flows. When the amount required to settle the current obligation, in whole or in part, is expected to be reimbursed by a third party, the Group recognized an asset, in respect of said reimbursement, up to the amount of the provision recognized, only when it is virtually certain that such indemnification would be received and when it may be measured reliably.
(2) Lawsuits
These Financial Statements include appropriate provisions with regard to lawsuits filed against Group companies which Group management believes would not be rejected or eliminated, although Group companies contest these claims.
These lawsuits are treated in accordance with IAS 37. Pursuant to these provisions, provisions are included in respect of claims likely to materialize (probability higher than 50%), which Group management believes, based on advice of legal counsel, to be appropriate to the circumstances of each and every case.
u. Share-Based Payments:
Share-based payments to employees, settled using Group equity instruments, are measured at fair value upon their grant date. The Group measures, upon the grant date, the fair value of equity instruments granted by using the Black & Scholes model. When the granted equity instruments do not vest until employees complete a specified period of service, the Company recognizes the share-based payment agreements in its financial statements over the vesting period against an increase in shareholders' equity, under capital reserve in respect of share-based payment. Upon each balance sheet date, the Company estimates the number of equity instruments expected to vest. Change in estimate relative to prior periods is recognized in the statement of operations over the remaining vesting period.
- C 22 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
v. Taxes on Revenue:
(1) General
Expenses (revenues) in respect of taxes on revenue include all current taxes, as well as total change in deferred tax balances, except for deferred taxes arising from transactions recognized in equity.
(2) Current Taxes
Current tax expenses are calculated based on taxable income of the Company and consolidated companies during the reported period. The taxable income differs from income before taxes, due to inclusion or exclusion of revenue and expense items which are taxable or deductible in different reporting periods, or which are not taxable or deductible. Assets and liabilities in respect of current taxes were calculated based on the tax rates and taxation legislation enacted, or effectively enacted, by the balance sheet date.
(3) Deferred Taxes
Group companies generate deferred taxes in respect of temporary differences between the value of assets and liabilities for tax purposes and their carrying amount in the financial statements. The deferred tax balances (assets or liabilities) are calculated using the tax rates expected upon their realization, based on the tax rates and taxation legislation enacted, or effectively enacted, by the balance sheet date. Deferred tax liabilities are usually recognized in respect of all temporary differences between the value of assets and liabilities for tax purposes and their carrying amount in the financial statements. Deferred tax assets are recognized in respect of all deductible temporary differences up to the amount for which taxable revenue is expected to allow for utilization of the deductible temporary difference.
In calculating deferred taxes, taxes which would apply in case of realization of investments in investees are not accounted for, since the Group intends to hold and develop said investments. In addition, the Company did not account for deferred taxes for profit distribution in said companies, since dividends are tax exempt.
Deferred tax assets and liabilities are stated on an offset basis, when an enforceable legal right exists to offset tax assets against tax liabilities, and when they refer to taxes on revenue imposed by the same tax authority, where the Group intends to settle the tax assets and liabilities on net basis. The Company and several consolidated companies are jointly assessed for taxes on revenue, therefore deferred tax assets and deferred tax liabilities of said companies are presented on offset basis.
w. Employee Benefits
(1) Post-Employment Benefits
Post-employment benefits at the Group include pensions, severance pay liability, adjustment pay to executives, redemption of sick pay and certain benefits to Company retirees. Some post- employment Company benefits are defined contribution plans and some are defined benefit plans. Expenses in respect of Company liability to deposit funds to a defined contribution plan are recognized in the statement of operations upon provision of employment services for which the Company is liable to make said deposit.
Expenses in respect of defined benefit plans are recognized in the statement of operations based on the Projected Unit Credit Method, using an actuarial estimation prepared upon each balance sheet date. The present value of Company obligations in respect of defined benefit plans is determined by discounting expected future cash flows expected from the plan using market yield of government bonds denominated in the currency in which plan benefits are to be paid, and having a term to maturity approximately equal to the expected plan settlement date.
- C 23 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Actuarial gain or loss in excess of 10% over the present value of the obligation in respect of a defined benefit plan and the fair value of plan assets as of the start of the period, whichever is higher, are amortized over the remaining average service duration expected for employees participating in the plan. Company liability in respect of a defined benefit plan, presented on the Company balance sheet includes the present value of the liability in respect of defined benefit, plus actuarial gain (less actuarial loss) yet to be realized, net of the fair value of plan assets.
(2) Other Long-Term Employee Benefits
Other long-term employee benefits are benefits expected to be utilized or payable in a period over 12 months from the end of the period in which the service qualifying for the benefit was rendered. Other employee benefits at the Company include the anniversary bonus. This benefit is recognized in the Statement of Operations according to the Projected Unit Credit Method, using actuarial estimates prepared upon each balance sheet date. The present value of Company obligation in respect of the benefit in question is determined by discounting expected future cash flows expected from the plan using market yields of government bonds denominated in the currency in which benefits are to be paid, and having a term to maturity approximately equal to their expected settlement date.
(3) Short-Term Employee Benefits
Short-term employee benefits are benefits expected to be utilized or payable in a period within 12 months from the end of the period in which the service qualifying for the benefit was rendered. Short-term employee benefits at the Company include Company liability in respect of wages, bonuses and paid leave. These benefits are recognized in the Statement of Operations when generated. The benefits are measured according to the non-capitalized sum the Company projects it will pay for realization of this entitlement. The difference between the short-term benefits to which an employee is entitled and the amount paid for them is recognized as a liability. Accumulated entitlement to compensation due to absences shall be classified as short term employee benefits, or as long term employee benefits based on the date on which the employee received the right to the benefit. As a result, the Group presents vacation benefits as short term employee benefits, measured at the height of the non-capitalized sum the Group expects to pay for the realization of this right.
(4) Early Retirement Plans
Company liability in respect of early retirement plans are recognized in the statement of operations when the Company is committed to a formal employment termination plan, including, at least, the site, position and estimated number of employees to be terminated, the benefits to which terminated employees are eligible and the date on which the plan would be executed. Furthermore, the time until implementation is complete should be such that material changes to the plan are unlikely. The benefit level is determined using the discount rate for government bonds.
x. Earnings per Share
The Company calculates basic earnings per share as regards gain or loss, attributed to holders of Company shares by dividing the income or loss attributed to holders of Company ordinary shares by the weighted average number of ordinary shares outstanding during the reported period. In order to calculate diluted earnings per share, the Company adjusts the earnings or loss attributed to holders of ordinary shares, and the weighted average number of shares outstanding, for the impact of all potentially dilutive shares.
y. Customer Loyalty Programs:
Transactions for the sale of services, wherein the company awards its customers with points, shall be treated as multi-component transactions, and the payment received from the customer will be allocated to its different components based on the fair value of the credit award. The proceeds attributed to the award shall be recognized as revenue when the credit awards are cashed and the Company’s commitment to supply the awards is upheld.
- C 24 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
z. Operating Segments:
The Company’s segment-based reporting is based on information used by the Company’s management for the purpose of evaluating the performance of the segments, and for the purpose of reaching decisions on the mode of allocating resources to the various operating segments. to IFRS 8 revised "Operating Segments: Disclosure Regarding Segment Assets” states that disclosure is to be provided regarding the measurement of assets of a reportable segment, only if such information is regularly provided to the chief operational decision maker. This Standard shall be applied retroactively to yearly reporting periods starting January 1 2010 or subsequently. In light of this, segment assets were not presented in these Financial Statements. Regarding the reporting on the Company's operating segments in accordance with IFRS 8, see Note 37 below.
aa. Presentation of Additional Balance Sheet:
The Company's management has decided not to present an additional balance sheet, despite the fact that it reclassified, as of December 31, 2009, aircraft leasing expenses to the amount of $4,478,000 from current prepaid expenses to non-current prepaid expenses.
The Company's management believes that as the above reclassification has a non-material impact on the data reflected in the Balance Sheet as of December 31, 2010, the presentation of an additional report for December 31, 2010 shall be, under the circumstances, irrelevant to the understanding of the Financial Statements and makes no contribution to the users of the Financial Statements for the receipt of financial decisions or for understanding the influence of certain transactions and events on the Company's financial status.
bb. Exchange Rates and Linkage Basis:
(1) Balances in foreign currency, or linked to foreign currency, are included in the Financial Statements according to official exchange rated published by the Bank of Israel and in effect as of the balance sheet date.
(2) Balances linked to the Consumer Price Index are presented using the most recent known CPI value on the balance sheet date.
(3) Below is data on USD exchange rates and the CPI in Israel:
As of December 31 2 0 10 2 0 0 9 2 0 0 8
Consumer Price Index – in points 117.8 114.7 110.4 USD/NIS exchange rate 3.549 3.775 3.802 USD/EUR exchange rate 0.749 0.694 0.718 USD/Pound Sterling Exchange Rate 0.646 0.618 0.685
For the Year Ended on December 31 Change in %: 2 0 10 2 0 0 9 2 0 0 8
Consumer Price Index – in points 2.7% 3.9% 3.8% USD/NIS exchange rate (6.0 %) (0.7%) (1.1%) USD/EUR exchange rate 7.9% (3.3%) 5.6% USD/Pound Sterling Exchange Rate 4.5% (9.9%) 37.4%
- C 25 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Note 3 - New Financial Reporting Standards and Clarifications Published
a. New standards and interpretations impacting the current period and/or previous reported periods:
Early adoption of IFRS 9 "Financial Instruments"
The Company has decided upon the early adoption of the first stage of IFRS 9 “Financial Instruments”, starting from 2010, regarding financial assets. In addition, the Group named January 1, 2010 as the start date for the standard’s application.
The standard is implemented retroactively. In accordance with the standard’s transitional directives, the Company has chosen not to match comparison data for previous periods.
The standard details the manner in which the Company has to classify and measure its financial assets. According to the standard, financial assets shall be classified as a whole according to the basis of the business model of the Company's management regarding those assets and on the basis of their contractual terms, as financial assets measured at fair value or depreciated cost.
Accordingly, debt instruments shall be measured after first recognition at depreciated cost when (1) the Company’s business model is to hold the assets with the aim of collecting contractual cash flows and (2) the contractual conditions of the asset set precise dates on which contractual cash flows consisting only principal and interest payments, are received.
In the event that one of the two conditions above is not upheld, the asset shall be classified as a financial asset at fair value via profit & loss.
In addition, even in the event that both of the above conditions are upheld, according to the standard the Company may, upon first recognition of the asset, designate the asset at fair value via profit & loss, if this designation significantly reduces accounting mismatch.
In accordance with IFRS 9, derivatives embedded in financial assets covered by this standard are not separated from the host contract.
Investments in capital instruments are classified and measured at fair value via profit & loss, except when these assets are not held for trade and the Company has designated these assets at fair value via other comprehensive income. Profits or losses deriving from financial assets designated at fair value via other comprehensive income are recognized as other comprehensive income and are not classified to profit and loss in subsequent periods. Dividends received for investments in capital instruments, including capital instruments designated at fair value via other comprehensive income, are recognized as revenue in profit & loss.
On the standard’s start date, the Company reviewed its financial instruments in existence as of that date. As a result:
1. It was tested and found that all debt instruments held by the Company are in compliance with terms according to which they can be presented as assets measured at depreciated cost.
2. The Company's investment in capital instruments were classified at fair value via profit & loss.
Publication of the Second Stage of IFRS 9 Regarding Financial Liabilities
In accordance with the standard’s transitional directives, the Company has chosen not to adopt the second stage of the standard in the matter of financial liabilities.
Regarding the implementation of the Standard in relation to the Maman Deal, see Notes 14 and 39a.
- C 26 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
b. New standards and clarifications, already in effect, that have no material impact on the current period and/or on previous reporting periods:
. IAS 17 (Revision) “Leases”
As part of the 2009 yearly improvement project, IAS 17 "Leases" was amended.
IAS 17 "Leases" states that land leases shall be classified as financial leases or operational leases using the general principles of the standard, taking into account that land is an asset with an infinite financial lifespan. Pursuant to the revision the general prohibition of classifying land leases as financial leases when the land does not pass on to the lessee at the end of lease period. The revision shall apply retroactively to yearly reporting periods starting January 1 2010. The revision shall be applied retroactively to existing leases when the required information is available at the beginning of the lease. When the required information is not available, land leases shall be reexamined on the date the revision is adopted.
. IAS 39 (Revision) "Financial Instruments: Recognition and Measurement" (regarding the designation of exposure to inflationary risks as hedging items"
This revision states, among other things, that changes in cash flows deriving from exposure to inflationary risk can be designated as hedging items. In addition the revision states that the internal value, unlike the time value of options purchased, is fit to serve as a hedging item of one side deriving from a projected transaction. The revision is applied retroactively to yearly reporting periods starting January 1, 2010, or subsequently.
c. New standards and clarifications that have been published and are not in effect, and which have not been adopted by the Group by way of early adaptation, which are expected to haveor may have an impact on future periods:
. IFRIC 19 "Removal of Financial Liabilities by Capital Instruments"
The interpretation establishes the accounting treatment regarding the removal of financial liabilities by issuing capital instruments. The interpretation established that in the event of such an occurrence, the liability shall be subtracted when the difference between its book value on the clearance date and the fair value paid, measured at the height of the fair value of the capital instruments issued, shall be charged to the Statement of Operations. This interpretation shall be applied retroactively to yearly reporting periods starting January 1, 2011, or subsequently. Early application is possible. At this stage the Company cannot estimate the impact of application of this interpretation on its financial status and operating results.
. IFRIC 14 (Revision) "Advance Payments on Account of Minimal Deposit Requirements"
This Amendment states that when measuring a plan's assets as regards a defined benefit plan, advance payments on account of minimal deposit requirements shall be included as part of the economic benefits available in the form of refunds from the plans or as a reduction in future deposits to the plan. This interpretation shall be applied retroactively to yearly reporting periods starting January 1, 2011, or subsequently. At this stage the Company cannot assess the impact of application of this interpretation on its financial status and operating results.
. IFRS 7 (Revision) “Financial Instruments: Disclosure"
The revision includes demands regarding the entity’s exposure to risk due to financial asset transfer transactions in which the transferring party retains a certain level of continuing exposure to the asset (“continuous involvement”), and regarding financial asset transfer transactions subtracted fully, carried out near the end of the reported period.
- C 27 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
The amendment applies on a prospective basis to yearly periods starting January 1, 2012. Early application is possible. The new disclosure is not required for reporting periods applying before the revision's first implementation.
. IAS 1 (Revised) "Presentation of Financial Statements" – Clarifications Regarding the Statement of Changes in Shareholders' Equity.
The revision establishes that other comprehensive income items shall be presented in the Statement of Changes in Shareholders' Equity or as part of the Notes, according to the company's accounting policy. Accordingly, companies can choose whether to present the details of the other comprehensive income items charged directly to the shareholders' equity over the course of the presented reporting periods in the Statement of Changes in Shareholders' Equity or in the Notes. This Standard shall be applied retroactively to yearly reporting periods starting January 1, 2011 or subsequently.
Note 4 - Critical Accounting Considerations and Key Sources for Estimates of Uncertainties
a . General
In applying Group accounting policy, as set forth in Note 2 above, Company management is sometimes required to exercise considerable judgment with regard to estimates and assumptions about the book value of assets and liabilities, which may not be available from other sources. These estimates and related assumptions are based on past experience and other factors deemed relevant. Actual results may differ from these estimates.
Estimates and underlying assumptions are regularly reviewed by management. Changes in accounting estimates are only recognized in the period in which a change was made to the estimate, if the change only affects that period, or are recognized in said period and in subsequent periods in cases where the change affects both the current period and the subsequent periods.
b . Critical Accounting Considerations and Key Sources for Estimates of Uncertainties
(1) Provisions for Legal Proceedings
As of December 31, 2010, claims pending against the Company amount to a total of $151 million. In addition, there are claims not quantified in monetary terms. A provision was made in respect of some of these claims to the amount of $7.4 million (the aforementioned claims and provisions exclude tax assessments issued to the Company – see sub-section 2 below). In order to review of the legal validity of the aforementioned claims, as well as to determine the probability of their realization to the Company's detriment, Company management relies on the opinion of legal and professional counsel. After the Company's counsel have formed their legal opinion and the Company's probability with regard to the claim subject, whether the Company would have to bear its outcome or may postpone it, Company management estimates the amount to be included in the financial statements, if any. Interpretation by the Company of the current legal position which differs from that of its legal counsel, different understanding by Company management of contracts as well as changes due to applicable legislation or addition of new facts – all may impact the value of the overall provision for legal proceedings pending against the Company, thereby materially impacting its financial standing and operating results.
(2) Income Tax and Social Security
The Company has tax assessments for which the tax results are uncertain. The Company recognized liabilities in respect of tax results of these transactions, based on management estimates, which rely on professional counsel with regard to the timing and amount of the tax liability which may arise from them. When the tax consequence of such transactions differ from management’s estimates, tax expenses will differ upon the determination of the final assessment (see Note 28.f regarding a settlement with the tax authorities).
- C 28 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
(3) Employee Benefits
The present value of the Company's severance pay liability, as well as that of a pension plan and other employee benefits, is based on multiple data determined based on actuarial estimate, using multiple assumptions, including with regard to the discount rate. Changes in actuarial assumptions may impact the carrying amount of the Company's severance pay and pension liabilities. The Company estimates the discount rate annually, based on the discount rate for government bonds. Other key assumptions are made based on prevailing market conditions, as well as on the Company's past experience. For further details of assumptions made by the Company, see Note 23.
(4) Aircraft Impairment
As set forth in Note 2.l above, for any aircraft fleet where indications of impairment exist, the Company estimates the recoverable amount for said fleet. The recoverable sum is sales price of the aircraft or its use value, whichever is higher. In estimating use value, the Company estimates future cash flows and deducts them to their current value using a discount rate reflecting current market estimates. In this framework the Company relied on projections pertaining to, among other things, expected scopes of activity, prices of flight tickets and bills of lading, operating costs and future interest rates. Material changes to these estimates, or part thereof, may impact the recoverable amount of said aircraft.
(5) Frequent Flyer Clubs
As stated in Note 2.q.(1) for establishing the balance of unearned revenues for frequent flyer points accumulated as of the report date and yet unused, the Company based its calculations on the sales prices of frequent flyer points to business partners (after adjustments) and on the Company's experience on the matter of point usage projections. Changes in management estimates regarding point values may impact the Company's revenues.
(6) Useful lifespan of Fixed Assets
Company aircraft are amortized throughout their useful lifespan. As stated in Note 2.j, Company Management studies the useful lifespan of all fixed asset items each yearly reporting period. Actual changes in the balance of useful lifespan will lead to changes in impairment rates.
(7) Fair Value of Financial Instruments
The Company presents derivative financial instruments at fair value. As stated in Note 2.o, the fair value of financial instruments classified as first grade is based on the use of prices quoted in active markets, the fair value of financial instruments classified as second grade is based on the use of observed data, direct or indirect, while the fair value of financial instruments classified as third grade is based on the use of data not based on observed market data, see Note 31.m.
Note 5 - Cash and Cash Equivalents
a. Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Cash and bank balances 36,061 1,416 Short term deposits 74,941 105,271 Total cash and cash equivalents 111,002 106,687
- C 29 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
b. Restricted Deposits As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Restricted deposits in favor of jet fuel hedging transactions - 7,003
As of December 31, 2010 the fair value of jet fuel hedging transactions was positive, and therefore no restricted deposits existed.
Note 6 - Short-Term Deposits
a. Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Short term bank deposits 63,565 7,933
b. As of December 31, 2010 – an NIS deposit worth $8,565 thousand (including accrued interest) deriving from the proceeds of option (Series 1) exercises received by the Company, greater than the sum of the "deficit" in the compensation fund of the entitled employees – as stated in Note 23.c.3.b (as of December 31, 2009 the deposit in question amounted to $7,933 thousand).
The Company is studying the existence of limitations regarding its ability to make use of the above balance of the proceeds according to the agreement with the State and with the workers' representatives. The Company approached the General Controller of the Ministry of Finance on this matter. As of the publication of the Financial Statements negotiations are taking place with the General Controller's Office at the Ministry of Finance in order to examine entitlement to the surpluses of the issue. The negotiations have yet to come to a conclusion. Until the matter is resolved, the deposit is presented against an obligation to the State of Israel.
Note 7 - Derivative Financial Assets a. Composition: Current Assets Non-Current Assets Total Assets As of December 31 As of December 31 As of December 31 2 0 10 2 0 0 9 2 0 10 20 0 9 2 0 10 2 0 0 9 Thousands of Dollars Derivative financial instruments, designated as hedging items: Jet fuel hedging transactions 30,020 6,469 4,291 2,255 34,311 8,724 Forward transactions for the purchase of foreign currency 12,170 4,737 - - 12,170 4,737 42,190 11,206 4,291 2,255 46,481 13,461
b. See note 25 below regarding derivative financial liabilities. c. See Note 31 below regarding financial instruments and projected exercise dates of the financial assets.
- C 30 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Note 8 - Trade Receivables
a. Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Open accounts 103,963 85,761 Credit card companies 18,380 15,422 Airlines (see 1 below) 13,035 13,162
135,378 114,345 Less - provision for doubtful debt (2,418 ) (2,259)
132,960 112,086
1. Most accounts between airlines are settled through the International Air Transport Association (IATA) clearing system.
2. Total trade receivable debts (less provisions for doubtful debts) to the Group as of December 31 2010 amounted to a total of $132,960 thousand (as of December 31, 2009 a total of $112,086 thousand), and included the sums presented above. The average credit for Company services provided is 27 days (in 2009: 27 days). Group customers are not required to pay interest for this period. The Group has, in general, several types of trade receivables in Israel and abroad: IATA agents, non-IATA agents and business customers. The credit rating of IATA agents is determined in accordance with parameters set by the Israel Airline Panel, BSP overseas and CASS as regards cargo. The bodies in question require collateral or guarantees for these agents in accordance with the credit quality of each trade receivable. In addition, the Company holds insurance for the credit risk of IATA agents in Israel. This insurance does not cover all the Company's exposure to credit risk. At the same time, according to the Company's estimates this risk is low. As of non-IATA agents, the Company requires guarantees and/or collateral, while for its business customers the Company holds credit risk insurance. On June 1, 2010 the Company joined the BSP (Billing & Settlement Plan), the IATA clearing program. This shift to the world’s most widely-used payment system constitutes a technological innovation and was designed to streamline and simplify the sales, reporting and accounting process for airline companies in dealing with travel agents, and allows better control and supervision of the airlines’ cash flow. The balance of Group trade receivables as of December 31, 2010 includes a total of $5,021 thousand of which their repayment date has passed (as of December 31, 2009: $3,121 thousand), but the Group, based on its past experience and on the payables' credit rating, has not made a provision to doubtful debts for them, as in its opinion they are collectable. The Group does not hold collateral for these debts.
The average debt period of trade receivable debts of which their repayment date has passed as of December 31, 2010 is 46 days (as of December 31, 2009 – 55 days).
b. Age of customer debts deviating from credit days established for which no provision to doubtful debts has been included: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
0-30 days 2,832 1,126 31-60 days 422 710 61-90 days 159 150 Over 90 days 1,608 1,135 Total 5,021 3,121
- C 31 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
c. Movement in the provision for doubtful debts: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Balance at the beginning of the year 2,259 1,498 Loss from impairment due to receivables 429 1,423 Amounts of doubtful debts written off (163 ) (523) Amounts recouped during the year (107) (139) Balance at the end of the year 2,418 2,259
In determining the likelihood of payment of customer debts, the Group reviews changes in customer credit quality from when the credit was granted through the reporting date. Concentration of credit risks is limited in light of the large customer basis and its distribution into various branches and geographical regions.
d. Age of trade receivable debts for which a provision for doubtful debts was made:
As of December 31 2010 2009 Thousands of Dollars
0-30 days 8 83 31-60 days 6 149 61-90 days 23 50 Over 90 days 2,381 1,977 Total 2,418 2,259
Note 9 - Other Receivables
Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Government institutions 2,731 4,476 Receivables due to renovation of leased engines 1,526 2,391 Receivables due to jet fuel hedging transactions 3,095 - Other receivables 13,528 9,288
Total 20,880 16,155
- C 32 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Note 10 - Prepaid Expenses
Composition:
Current As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Unused flight tickets commissions 16,913 15,587 Frequent flyer point commissions 1,501 1,477 Aircraft leases 4,631 * - Others 3,950 3,331
Total 26,995 20,395
Non-Current As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Frequent flyer point commissions 2,462 2,578 Aircraft leases 5,659 * 4,478
Total 8,121 7,056
*Restated - see Note 2. aa.
Note 11 - Inventory
Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Jet fuel for consumption 10,248 13,282 Materials and foodstuff 5,278 4,619 Chemicals 3,068 3,211 Other 162 835 Total 18,756 21,947
Note 12 - Linkage Conditions – Assets
Current assets - distribution by linkage conditions: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars Monetary items: In USD or linked 281,882 193,926 In Israeli currency (NIS) 43,826 23,389 In or linked to Euro 20,060 18,541 Other foreign currency or linked to it 24,829 20,736 370,597 256,592
Non-monetary items 45,751 46,820
Total 416,348 303,412
- C 33 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Non-current assets - distribution by linkage conditions: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars Monetary items: In USD or linked 5,662 8,208 In Israeli currency (NIS) 50,849 36,222 56,511 44,430
Non-monetary items 1,248,345 1,323,660
Total 1,304,856 1,368,090
Note 13 - Long-Term Bank Deposits
As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Bank deposits in NIS, unlinked. 1,869 1,839 Interest Rates 1.7-2.4 1.7-2.1
The unlinked NIS bank deposits as of December 31, 2010 and December 31, 2009 are used as collateral for the repayment of bank loans received by Company employees. The deposits have no predetermined redemption date.
Note 14 - Investments in Other Companies As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Investment in Maman (1) 10,324 - Investment SITA (2) 1,228 1,357 11,552 1,357
1. The investment in Cargo Terminals and Handling Ltd. (“Maman”) is presented at fair value. As of December 31, 2010 the Company holds 2,837,837 ordinary shares, worth 1 NIS NV each, constituting 7.5% of Maman’s issued and paid-up share capital (value as of December 31, 2010 is $5,964 thousand). In addition, the Company holds options exercisable to ordinary shares at a rate close to 10% of Maman’s issued and paid-up share capital (value as of December 31, 2010 is $4,360 thousand). For further details, see Note 39.a.
2. Investment in SITA - Societe Internationale de Telcommunications Aeronautiques (“SITA"). SITA is a cooperative non-profit association of airlines and related bodies intended mainly to provide international communications services to airlines and other factors. As of December 31, 2010, the Company held 26 shares worth €5 NV each, constituting 0.4% of SITA’s share capital.
- C 34 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Note 15 - Investment in Subsidiaries
a. Subsidiaries:
The Group's subsidiaries:
Country of Holding Rate in the Rights Extant of Investment in Company name Incorporation of the Capital of Subsidiary Subsidiary (*) As of December 31 As of December 31 2 0 10 2 0 0 9 2 0 10 2 0 0 9 % % Thousands of Dollars Held Directly Tamam (1) Israel 100% 100% 756 1,617 Borenstein (2) U.S.A. 100% 100% 4,491 4,367 Superstar (3) U.K. 100% 100% (65 ) (32) Sun D'Or (4) Israel 100% 100% 3 3 Katit (5) Israel 100% 100% - -
(*) The extent of the investment in a company held directly is calculated as a net sum based on the consolidated statements, charged to the shareholders of the parent corporation, of total assets less total liabilities, plus loans given subsidiaries.
(1) Tamam Aircraft Food Industries (BGN) Ltd. ("Tamam")
Tamam is primarily engaged in the production and supply of prepared kosher meals for airlines. Most of Tamam’s sales are to the Company and a small fraction to other airlines and customers. Tamam provides the Company with catering and food services on its aircraft at prices specified by agreements. Tamam's plant is located at Ben Gurion Airport. In accordance with its agreement with the Israel Airports Authority ("IAA"), it may use the area owned by IAA in exchange for agreed-upon authorization fees based on Tamam's turnover. Following the opening of BGN 2000, Tamam estimates that it will have to relocate its plant from its present location and move to a new location. This move is not expected to occur prior to 2015.
(2) Borenstein Caterers Inc. (USA) - (“Borenstein”)
Borenstein, a fully owned subsidiary, is a US corporation operating out of New York’s JFK, and is mostly engaged in the production and delivery of prepared kosher meals for airlines and other institutions, with the Company being its main customer, holding all of its shares. The investment in Borenstein in 2010 is after offsetting dividends received in 2010 to the amount of $20 thousand.
(3) Superstar Holidays Ltd. (England) – (“Superstar”)
Superstar – a company registered in England and Wales and fully owned by the Company, serving as a tourism wholesaler, marketing tourism packages as well as airline tickets to travel agents and individual travelers. Superstar has a branch in Israel, as well as branches in several cities abroad.
In October 2010 El Al provided Superstar with a £110 thousand loan. This loan bears no interest.
The investment as of December 31, 2010 includes loans to Superstar to the amount of $488 thousand (a loan to the amount of $322 thousand as of December 31, 2009). These loans are in pounds sterling and bear no interest.
- C 35 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
(4) Sun D'Or International Airlines Ltd. ("Sun D'Or")
Sun D'Or operates charter flights within the framework of a commercial policy coordinated with the Company, by means of aircraft leased from the Company, or through the Company. In addition, Sun D’Or sells seat packages on EL AL flights to agents in exchange for commissions. Sun D'Or has a commercial operation certificate, valid for an indefinite period, to transport passengers and cargo on charter flights to and from Israel. Over the course of 2009 and 2010 the Company was appointed designated carrier to various European destinations.
According to the method used by the two companies to settle their accounts, Sun D’Or breaks even at the end of each year.
Regarding the announcement made by the Civil Aviation Authority to Sun D’Or regarding the revocation of its operating license, see Note 42. i.
(5) Katit Ltd. ("Katit")
Katit is a fully-owned subsidiary Company that operates several restaurants for Company employees at Ben Gurion Airport, commissaries in the Company's office buildings and the King David Lounge at BGN. In return for the services Katit provides the Company, the Company covers the surplus of operating costs over expenses created by Katit at any time.
b. Affiliated companies:
The Group's affiliated companies:
Country of Incorp- Holding Rate in Share Extant of Investment in Name of Affiliate oration Capital of Affiliate Affiliated Company (*) As of December 31 As of December 31 2 0 10 2 0 0 9 2 0 10 2 0 0 9 % % Thousands of Dollars
Included Directly Air Tour (1) Israel 50% 50% 13 13 ACI (2) Israel 50% 50% 4 4 Kavei Chufsha Ltd. (3) Israel 20% 20% 676 631 693 648
(*) The extent of the investment in a company held directly is calculated as a net sum based on the consolidated statements, charged to the shareholders of the parent corporation, of total assets less total liabilities, plus loans given to affiliates, and plus the portion of the dividends received from them.
1. Tour Air (Israel) Ltd. ("Air Tour ")
The company mainly deals in the marketing of El Al flights and special promotions to all El Al destinations. The shares of Air Tour are held by Israeli travel agents (50%) in Type A of ordinary shares and by the Company (50%) in Type B of ordinary shares. Air Tour markets the Company’s flights and special promotions to all of its flight destinations. The shares held by the Company grant it the right to participate and vote in Air Tour’s General Meetings with 50% voting rights and to appoint half of its directors, but do not grant it the right to receive dividends or profits, other than profits derived from investing in Air Tour’s share capital.
- C 36 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
2. Air Consolidators Israel Ltd. ("ACI")
ACI is primarily engaged in the consolidation of air cargo at BGN to facilitate the reduction in price of air shipments. Air transport is carried out by the Company, at special prices, and by foreign companies. The shares held by the Company entitle it to participate and vote in the General Meetings of ACI to the extent of 50% and to appoint half of its board members, without the right to receive earnings by way of a dividend distribution or any other benefit, other than earnings and dividends derived from capital gains.
3. Kavei Chufsha Ltd. (“Kavei Chufsha”)
The main area of activity of Kavei Chufsha is the marketing and sale of charter flights to and from Israel and providing associated tourism services. Company sales are to individuals, groups and agents. The investment in Kavei Chufsha is after offsetting dividends received from Kavei Chufsha to the amount of $159 thousand in 2009.
Composition of the investment in affiliates: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars Investment in shares: Cost of shares 57 57 Portion of profits accumulated from purchase date, net 636 591 Total investment in affiliated companies 693 648
Note 16 - Fixed Assets
a. Composition: Payments On Aircraft Account and of Vehicles Buildings Aviation Aircraft Machinery Computers and
and Equipment and And Ground and Office Workshop (1) (2) (3) Facilities Engines Equipment Furniture Equipment Total Thousands of Dollars Cost As of January 1, 2010 106,597 2,355,741 14,097 60,197 128,598 7,830 2,673,060 Reclassification - - (1,491) - - - (1,491) Additions 3,936 32,090 1,920 2,927 5,278 397 46,548 Disposals - (67,132) - (1,302) - (42) (68,476)
As of December 31, 2010 110,533 2,320,699 14,526 61,822 133,876 8,185 2,649,641
Accumulated depreciation As of January 1, 2010 74,602 1,104,292 - 53,447 120,535 7,254 1,360,130 Annual 2,798 95,092 - 1,852 4,971 620 105,333 depreciation Disposals - (46,251) - (1,216) - (42) (47,509)
As of December 31, 2010 77,400 1,153,133 - 54,083 125,506 7,832 1,417,954
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Payments On Aircraft Account and of Vehicles Buildings Aviation Aircraft Machinery Computers and
and Equipment and And Ground and Office Workshop (1) (2) (3) Facilities Engines Equipment Furniture Equipment Total Thousands of Dollars Depreciated Cost: 33,133 1,167,566 14,526 7,739 8,370 353 1,231,687 As of December 31, 2010
Cost As of January 1, 2009 103,722 2,428,315 36,181 59,728 123,916 7,821 2,759,683 Reclassification - 22,240 (22,240 ) - - - - Additions 2,875 169,231 156 1,726 4,682 9 178,679 Disposals - (264,045) - (1,257) - - (265,302)
As of December 31, 2009 106,597 2,355,741 14,097 60,197 128,598 7,830 2,673,060
Accumulated depreciation As of January 1, 2009 72,177 1,198,567 - 52,497 115,299 6,961 1,445,501 Annual 2,425 112,498 - 2,207 5,236 293 122,659 depreciation Disposals - (206,773) - (1,257) - - (208,030)
As of December 31, 2009 74,602 1,104,292 - 53,447 120,535 7,254 1,360,130
Depreciated Cost: As of December 31, 2009 31,995 1,251,449 14,097 6,750 8,063 576 1,312,930
Annual depreciation rate - 5%-20% 5%-33% 10%-20% 4%-10% (See b.2.) (mainly 10%) (mainly 33%) (mainly 15%)
(1) See j. below. (2) See b. below. (3) See c. below.
- C 38 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding b. Boeing aircrafts and aviation equipment:
1. Composition: 2 0 10 2 0 0 9 Quantity Aircraft Fleet Accumulated Accumulated and Model Cost Depreciation Balance Cost Depreciation Balance As of December 31 2010 Thousands of Dollars
747-400 5 Passenger aircrafts 472,366 278,343 194,023 472,366 252,314 220,052 Spare engines 6,600 4,869 1,731 6,600 4,563 2,037 Engine overhauls 85,680 38,640 47,040 85,680 38,640 47,040 564,646 321,852 242,794 564,646 295,517 269,129
747-200F 1 Cargo aircrafts 83,824 83,824 - 83,824 83,824 - Spare engines 17,481 17,481 - 17,481 17,481 - Engine overhauls 21,884 18,557 3,327 40,784 30,699 10,085 123,189 119,862 3,327 142,089 132,004 10,085
757-200 3 Passenger aircrafts 108,543 87,936 20,607 108,543 83,269 25,274 Engine overhauls 24,402 10,498 13,904 27,802 10,838 16,964 132,945 98,434 34,511 136,345 94,107 42,238
* 737-700/800 8 *** Passenger aircrafts 272,569 65,561 207,008 272,569 56,867 215,702 Spare engines 6,390 2,998 3,392 6,390 2,721 3,669 Engine overhauls 42,021 17,224 24,797 40,155 11,456 28,699 320,980 85,783 235,197 319,114 71,044 248,070
767 4 200ER (passenger 156,377 136,496 19,881 156,377 131,127 25,250 aircrafts) Spare engines 1,649 1,217 432 1,649 1,141 508 Engine overhauls 36,708 21,013 15,695 57,008 38,037 18,971 194,734 158,726 36,008 215,034 170,305 44,729
*** 777-200 6 Passenger aircrafts 667,019 176,084 490,935 665,703 153,298 512,405 Spare engines 21,157 7,414 13,743 21,157 6,330 14,827 Engine overhauls 67,030 33,515 33,515 67,030 33,515 33,515 755,206 217,013 538,193 753,890 193,143 560,747
27 2,091,700 1,001,670 1,090,030 2,131,118 956,120 1,174,998
Accessories and spare parts - general 228,999 151,463 77,536 224,623 148,172 76,451 2,320,699 1,153,133 1,167,566 2,355,741 1,104,292 1,251,449
* Includes three aircrafts in financing leases – see Note 16.d.3. ** Including the cost of investments in leased aircrafts via operational lease to the amount of $2.8 million, deducted across the lease period. *** Including three leased aircrafts via financial lease – see Notes 16.d.1 and 16.d.2.
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2. Depreciation Rates:
The annual depreciation rate of each aircraft is decided taking into account its residual value, as it appears in the prevailing aircraft price list, which estimate the value of an aircraft for the year that the management assesses the use to the Company of that aircraft will end.
The following are depreciation rates for Company aircrafts relative to cost (after deduction of residual value) for the year 2010:
Average Annual Depreciation Aircraft Rate
737 5.2% 747-400 7.4% 757 5.7% 767 4.2% 777 5.1%
As of December 31, 2010, the balance of years remaining for the Company's aircraft fleet is between one and eighteen years.
The annual depreciation rate of the spare engines (engine body) was determined according to the average number of years remaining for the fleet of aircraft to which the engines are allocated.
Engine overhauls are depreciated according to potential engine hours that the overhaul added to that engine, and according to an estimate of the projected engine hours for that aircraft fleet in the coming years.
As of December 31, 2010, the balance of years remaining for general engine overhauls ranges between 5 months and 8 years.
Accessories and spare parts allocated to a specific aircraft fleet are depreciated over the average remaining life of that fleet. Accessories and spare parts that are not allocated to a specific fleet are depreciated at according to the average remaining life span of the entire Company fleet. c. Payments on Account of Aircraft and Aviation Equipment – Composition: As of December 31 2010 2009 Thousands of Dollars
Advance payment for the purchase of four 777-200 aircrafts, see Note 16.e.1. - 10,606 Payment for the option to purchase two 777-200 aircrafts, see Note 16.e.1. - 2,000 Advance payment on account of the future purchase of aircrafts from Boeing, see 13,526 - Note 16.e.1. Advance payment for the purchase of a 747-400 aircraft from RBS, see Note 42. e. 1,000 - Others - 1,491 14,526 14,097
As part of its equipping plan in November 2010 the Company made an initial deposit with Boeing (see Note 16.e.1.(c)). d. Aircraft under financing leases:
1. In June 2002, the Company received and operated a fourth 777-200 aircraft. The aircraft, which is subleased to the Company for 12 years in exchange for leasing fees identical in amount to the repayment of the principal and interest amounts payable to Citibank. The Company has an option to acquire this plane at the end of the loan-repayment period for $1.00.
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The aircraft is included in the Financial Statements under Company fixed assets (depreciated throughout the economic enjoyment period expected from it) against the listing of a long term liability due to the loan received from Citibank to finance most of the cost of the aircraft.
2. In July and August 2007, the Company received and operated two new 777-200 aircraft (the fifth and sixth of this model) from Boeing. In July 2007, a financing agreement was signed with a consortium of several foreign banks to finance the purchase of the planes. For this purpose, a new foreign company, Yochevet Leasing LLC was established in Delaware (hereafter: "the Foreign Company”). The ExIm Bank provided a bank guarantee to the lending banks. The lending banks, the foreign company, ExIm Bank and the Company appointed Wells Fargo as trustee of the collateral (hereafter: “the Trustee”) Liens were placed on the shares of the Foreign Company in favor of the Trustee. Liens were placed on the aircrafts by the Bank. In addition, the Trustee appoints the directors of the Foreign Company. Both aircrafts, which are leased by the foreign company from Boeing, are subleased to the Company for 12 years in exchange for leasing fees identical in amount to the repayment of the principal and interest amounts payable to the lending banks. The Company has an option to acquire those aircrafts at the end of the loan-repayment period for $1.00. The two aircrafts are included in the financial statements within the Company’s fixed assets (depreciated over the expected period of economic benefit), against an entry to long-term loans for the loan received to finance most of the aircraft’s cost.
3. On April 10, 2008, the Company signed an agreement with a Spanish airline, whereby 3 new 737-800 aircrafts would be acquired at a total investment of $49 million per aircraft. The aircrafts were delivered in April, May and June 2009. To complete the transaction and finance the purchase, the Company received the approval of the Export-Import Bank of the United States (hereafter: "the Bank" or “ExIm") for $37.5 -$38 million in financing for each aircraft. In each of the above aircrafts deliveries the Company signed an agreement with the Spanish airline to cancel the direct purchase of the aircraft in question, so that the aircraft would be sold by the Spanish airline to Boeing, with the Company purchasing the aircraft directly from Boeing. Immediately prior to the aircraft delivery dates, for financing purposes, financing agreements were signed with ExIm to purchase the aircrafts. For this purpose 2 new foreign companies were founded in Delaware named Miriam Leasing LLC and Aaron Leasing LLC (hereafter: "the Foreign Companies"). The ExIm Bank, in addition to financing, also provided bank guarantees for the transaction. The ExIm Bank (as lender and guarantor), the Foreign Companies and the Company appointed Wells Fargo as trustee (hereafter: "the Trustee"). Liens were placed on the shares of the Foreign Company in favor of the Trustee. Liens were placed on the aircrafts by the Bank. In addition, the Trustee appoints the directors of the Foreign Company. The three aircrafts, which are leased by the Foreign Company from Boeing, are subleased to the Company for 12 years in exchange for leasing fees identical in amount to the repayment of the principal and interest amounts payable to the lending banks. The Company has an option to acquire those aircrafts at the end of the loan-repayment period for $1.00. The three aircrafts are included in the financial statements within the Company’s fixed assets (depreciated over the expected period of economic benefit), against long-term loans for the loan received to finance most of the aircraft's cost. For further details regarding terms of loans received for the aircrafts, see Note 22.d.3. e. Aircraft and engine purchase and sales agreements:
1. a) In March 2008 an agreement was signed with the aircraft manufacturer Boeing whereby it would acquire from Boeing four new wide-bodies and long-ranged 777-200 ER aircraft (hereafter: "the Agreement"). The Agreement was approved by the Company's Board of Directors on April 30, 2008. The original delivery dates for the aircraft were set for January 2012, April 2012, November 2012 and January 2013. Total acquisition cost for the four aircrafts, including spare parts and installations, amounts to $576 million. In accordance with the Agreement, the payments for each aircraft will be made starting two years before each aircraft is delivered to the Company. Pursuant to terms of this agreement, the Company was granted an option to convert the aforementioned acquisition into new 777-300 ER aircrafts. Exercise of the option in question was to be decided by December 31, 2009, subject to the fact that Boeing would not be obligated to supply the aircrafts on the above delivery dates (this date has been extended by the parties from time to time).
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Furthermore, the agreement grants the Company another option to acquire two additional aircrafts from the same model, to be delivered to the Company in 2014 and 2015, in accordance with terms set forth in the agreement. The Company has paid Boeing an advance payment for the purchase of the aircrafts and payment for the additional option as stated above.
b) Due to material changes occurring to the aviation industry since the signing of the agreement, including the global market crisis and the impact of these changes on the economic, business and financial environment in which the Company is active, and after re-examination of the Company’s existing aircraft fleet and required adjustments to it, the Company has approached Boeing and Boeing has accepted the Company's request, and on April 29, 2010 the parties signed a letter of consent to cancel the Agreement, and agreed upon the conditions according to which the Company would be entitled to make use of a sum equal to the advance payments paid by it pursuant to the agreement, this for new aircraft purchase transactions in the coming years. The cancellation of the agreement in question has no impact on the Company's Financial Statements. A strong and extensive relationship exists between the Company and Boeing and the cancellation of the agreement was out of mutual understanding and in light of the good relationship between the parties. The Company is continuing to study its business strategy and long and short term equipping needs, adopting to general market trends and in accordance with the Company’s activities.
c) On February 7, 2011 an agreement was signed with aircraft manufacturer Boeing (“the Agreement) for the purchase of four new Boeing 737-900ER aircrafts and two additional aircrafts of the same model convertible to purchase options. In addition, the Company was granted the option to purchase two additional aircrafts of this model (“the Option”). In this Agreement the Company was granted conversion rights for other models as well as associated rights. The comprehensive value of the agreement is estimated at between $215 million and $230 million (respectively for four to six aircrafts, as purchased in practice, without the option), and reflects an average market value of an aircraft of this model and similar production year, in accordance generally accepted industry price lists and subject to adjustments and investments in accordance with the version agreed upon by the parties, including linkage of aircraft prices, using an agreed-upon linkage formula. The payments for each aircraft will be made two years before each aircraft is delivered to the Company, or according to other payment options the Company may choose. Furthermore, the parties agreed upon conditions for the use of advance payments made by the Company to Boeing for previous agreements. Note that as of the signing date the Company has made advance payments for six aircrafts to the amount of 1% of the purchase price and an additional advance payment was made for the aforementioned option, upon signing the agreement. At this stage the Company has not yet reached a final decision regarding the transaction’s financing and the Company is considering its various options. According to the agreement, the aircrafts are expected to join the Company’s aircraft fleet between late 2013 and 2016. The aircrafts are expected to serve the Company in short and medium ranges (Europe and other destinations) and shall replace narrow-bodied aircrafts as per Company strategy. The aircraft shall be operated in a 160-seat configuration, divided into two classes. Note that these are aircrafts of a new and advanced model, with modern engines and advanced internal configurations.
2. On January 10, 2008, the Company signed an agreement to acquire a 747-400 passenger aircraft. The aircraft was manufactured in 1994, and was delivered to the Company in October 2008. In 2008 the Company paid the entire proceeds, to the amount of $50 million, for the purchase of the aircraft, investments for its adoption at the Company and costs of additions and installations needed to be carried out on the aircraft so as to adapt it to the Company's needs. Self financing amounted to $14 million, with the balance financed by loans, to the amount of $36 million, in accordance with a long-term credit agreement with a foreign bank. For further information regarding the terms of the loan received, see Note 22.d.2.
3. On July 17, 2008 the Company signed an agreement for the sale of two Boeing 767-200 aircrafts, manufactured in 1983, owned by the Company. The delivery of one 767-200 to a Philippine airline was completed on October 15, 2008, this after the entire proceeds for this aircraft, a total of $6.5 million U.S., had been paid to the Company prior to the signing of the agreement. The Company listed a pre-tax capital gain of $4.7 million for the sale of the aircraft in 2008. As regards the sale of the second 767-200, the intended purchaser, a Singapore investment company, informed the Company that it would be unable to meet payments for the aircraft due to difficulties in securing bank financing and therefore would be unable to purchase it, leaving the $325 thousand advance payment in the Company's possession.
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4. On February 23 2009 a Boeing 757-200 possessed by the Company, manufactured in 1987, was sold and leased back to the El Al Group. The aircraft was purchased by a Panamanian aircraft leasing company. The Company received $9 million in return for the aircraft. According to the agreement, the Group shall lease the aircraft under market conditions for a 22 month period, with the option to extend the lease for an additional 12 months, as well as a monthly credit for engine maintenance calculation amounting to $1.8 million. The capital gains created by the transaction were not material. In July 2010 the Company decided to exercise its option to extend the lease, starting December 2010, for an additional 12 months.
5. In April 2009 two Boeing 767-200 engines were sold to Volvo Aero Services Corp (VAS) in return for a total of $1.8 million. In January 2010 a consignment agreement was signed for the sale of the aircraft parts to VAS. Due to the agreement the Company recognized $300 thousand as revenues in 2010.
6. On May 18, 2009, a Boeing 757-200, manufactured in 1990, in the company's possession was sold and leased back by the El Al Group via operational lease. The aircraft was purchased by a Panamanian aircraft leasing company. The Company received $11.5 million in return for the aircraft. According to the agreement, the Group will lease the aircraft under market conditions for a 27 month period. As a result of the transaction, the Company recognized an additional $2.6 million expense in its Financial Statements for the year 2009.
The above aircrafts purchases are in accordance with the Company's business strategy to act to generally refresh its aircraft fleet, in accordance with the El Al 2010 strategic plan. f. Depreciation Policy
In accordance with the Company's projections regarding the decommissioning of the three 757 and four 767 aircrafts owned by the Company, the residual values of these aircrafts and resulting depreciation costs were updated. Additionally, in light of the relatively close decommissioning date of these fleets, and concrete price quotes received by the Company regarding the aircrafts, it was decided that the residual values of these fleets shall be set according to the aircraft price lists in "market value" values reflecting a lower value, and not in "MID" values, as was formerly practiced regarding these fleets (and all fleets). Following the above change in estimates, the Company recognized an additional depreciation expenses of $2.4 million in 2010. g. Impairment of fixed assets
As set forth in Note 2.l above, for any aircraft fleet where indications of impairment exist, the Company estimates the recoverable amount for said fleet. The recoverable amount is the sales price of the aircraft or its value of use, whichever is higher. In estimating value of use, the Company estimates future cash flows and deducts them to their current value using a discount rate reflecting current market estimates. Within this framework the Company relied on projections pertaining to, among other things, expected scopes of activity, prices of flight tickets and bills of lading, operating costs and future interest rates. Material changes to these estimates, or to any part thereof, may impact the recoverable amount of said aircraft. Over the course of the reported period, the Company examined the recoverable amount of aircraft fleets in which signs of impairment were evident. As regards the recoverable amount of these aircraft fleets, in which signs of impairment were detected, it was found that the recoverable amount for each aircraft fleet surpasses its depreciated cost as of that date. Accordingly, no provision for the devaluation of aircrafts and engines was made in these Financial Statements. h. Ratio of Loan Balance to Collateral
Over the course of the reported period the Company was required to provide aircrafts in its possession as an additional bank guarantees due to loans taken to finance its aircraft fleet. As of this report, no difference exists in the loan balance to guarantee ratio, see Note 22.g.1. i. Unrestricted Assets
The Group's total fixed assets as of December 31, 2010 is $1,232 million. The Group's key assets are aircrafts and spare engines, which their depreciated cost as of December 31, 2010 is $1,090 million. The depreciated cost of the Group's main assets, as stated, that are not restricted by a third party amounts to a total of $23 million. In addition, as of the balance sheet date, the Group possesses parts and other fixed assets to the amount of $142 million, free of any encumbrance.
- C 43 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding j. Buildings and Installations: As of December 31 2 0 1 0 2 0 0 9 Accumulated Accumulated Cost Depreciation Balance Cost Depreciation Balance Thousands of Dollars
Building, aircraft hangers, warehouses, workshops and offices at BGN. 73,012 45,920 27,092 69,407 44,354 25,053 Leasehold improvements of rented 23,045 17,826 5,219 22,772 16,657 6,115 offices Freehold offices 2,952 2,130 822 2,894 2,067 827 Passenger and cargo terminals 11,524 11,524 - 11,524 11,524 - Total 110,533 77,400 33,133 106,597 74,602 31,995 k. Real Estate Usage Rights and Building Rental Fees:
For details regarding usage rights to real estate at Ben Gurion Airport and commitments for the rental of buildings in Israel and abroad see Note 29.d.2 below. l. Aircraft and Engine Maintenance Agreements
In January 2009 the Company signed an agreement to provide heavy maintenance and logistical support upon request to Nepal Airlines for Boeing 757 aircrafts. In March 2009 the Company signed an agreement with Pratt & Whitney for the maintenance of PW 4000 engines installed in Boeing 767 and 747-400 aircrafts in the Company's service. Some of these engines will be in the framework of an insurance agreement, according to which payment to the repairing party shall be calculated according to engine hour performance and the engines will be maintained by the repairing party. Payment for repair of the remaining engines shall be according to work receipts invested in the repairs. m. Assets Pledged as Collateral
For details regarding the Group's assets pledged as collateral for the Group's liabilities, see Note 41 below. n. Cargo Aircraft Activity
In this field of operations, the Group offers cargo transport services in cargo aircrafts from Israel to destinations to and from Israel; cargo transported from one foreign country to another foreign country (Fifth Freedom), for example from Liège to New York; or cargo transported in the context of Sixth Freedom (indirect flights via stopovers in the home country of the airlines), for example from Asia to Europe or the U.S. with a stopover in Israel. The Group differentiates between three main destination groups: (1) North America; (2) Europe; (3) East and Central Asia. During the reported year, the services offered by the Group in this field of operations were cargo transport services to one destination in Europe, one destination in North America and one destination in East Asia. Moreover, the Company offers cargo services to many additional destinations by means of the Group’s passenger aircrafts or by means of cooperative arrangements with other airlines and also by means of land transport from the airport. Prior to the approval of the report, the Company makes use of two cargo aircrafts – one Boeing 747-200 owned by the Company and an additional leased Boeing 747-400. The second 747-200 owned by the Company is no longer in service due to the need for major maintenance works, which were not carried out by the Company. In November 2009 the conclusions of the public committee established by the Minister of Transportation and Road Safety to study the Israeli cargo transport industry and to study the state of Israeli airlines dealing in cargo shipping were published, the key points being as follows:
1) The State shall study the cost of the minimal short term response for the defensive need to transport cargo in times of emergency. Information on cost will allow a well-established response to be made to the State's response to the El Al query. 2) The State shall study the request made by CAL regarding assistance with collateral. If it is decided to assist CAL, this assistance shall be contingent on the Company's commitment to operate recruit able aircrafts in times of emergency. 3) The Committee saw fit to note that it saw nothing wrong in the existence of cooperation between El Al and CAL, insomuch as this leads to the existence of a fleet for transporting cargo in times of emergency without causing a - C 44 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
material impact to competitiveness. In the event that the companies approach the Restriction of Trade Commissioner with a request for collaboration in the area of cargo shipping, the Committee recommends that approval shall be made conditional, inter alia, on the assurance of proper availability of emergency cargo aircraft. Subject to this, the Committee recommends that insomuch as Government ministry opinion is required on the subject, the subject shall be considered. 4) The paragraph in the CAL operating license precluding it from entering into collaboration agreements shall be cancelled. 5) The possibility of establishing an inter-ministerial committee headed by the Ministry of Defense and with the participation of the Ministry of Transportation, the CAA and the Ministry of Finance, to study specific issues pertaining to cargo shipping, shall be considered.
Note 17 - Intangible Assets
a. The following is the composition and movement of this item:
Usage Rights to Security Equipment Software Total Thousands of Dollars Cost Balance as of January 1, 2010 4,271 6,206 10,477 Purchases 236 2,818 3,054 Disposals - (1,294) (1,294) Balance as of December 31, 2010 4,507 7,730 12,237
Accumulated amortization: Balance as of January 1, 2010 1,999 974 2,973 Amortization 450 970 1,420 Balance as of December 31, 2010 2,449 1,944 4,393
Depreciated Cost As of December 31, 2010 2,058 5,786 7,844
Cost Balance as of January 1, 2009 5,703 4,656 10,359 Purchases 405 1,550 1,955 Disposals (1,837) - (1,837) Balance as of December 31, 2009 4,271 6,206 10,477
Accumulated amortization: Balance as of January 1, 2009 1,433 308 1,741 Amortization 566 666 1,232 Balance as of December 31, 2009 1,999 974 2,973
Depreciated Cost As of December 31, 2009 2,272 5,232 7,504
Annual depreciation rate 7%-33% 20%
b. Rights of Use of Security Equipment
The Company pays a relative portion of the security costs of the Government of Israel intended for safeguarding the Company's passengers and aircrafts from acts of war and terror, as set from time to time in Government resolutions. Accordingly, the Company lists under intangible assets the payments made for its share in financing the protective systems and security inspection equipment. The Company has an arrangement with the Ministry of Defense, according to which this equipment will be used by the Company exclusively over its anticipated useful economic life.
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c. Software:
This section mainly covers the Amadeus Project and the ERP Project.
In June 2010 the Company signed a settlement with IBM constituting a solution to the financial dispute between the parties resulting from the cancellation of the agreement which includes, among other things, payment by the Company for the purchase of rights to interim products produced prior to the project's cancellation, dismissal of the mutual claims and arrangement of compensation between the Company and IBM. The Company is conducting talks with Remco regarding the settlement agreement and the dismissal of mutual claims between the parties. The Company listed a $1.3 million expense in the reported year as a result of the erasure of investment components that failed to reach realization and an additional sum of $0.3 million for a final payment as a result of the project agreement. The Company has begun the process of receiving new proposals from various bodies (RFP) for the implementation of a staged ERP project for selected Company organizational units in Israel and around the world. The process of selecting the implementing party has yet to be completed.
d. Participation in security costs:
Pursuant to the resolutions dated January 27, 2008 and August 24, 2008 regarding the participation of the State of Israel in the Company's security costs, on February 1, 2009 the Israeli Government passed an updated resolution regarding participation in the security expenses of Israeli airlines (following the resolutions dated January 27, 2008 and August 24, 2008), as follows: " a. To increase the participation rate in security expenses in Israeli airlines to 60% from 2009 onward. Implementation of the resolution shall take place immediately after the Knesset passes its 2009 budget. b. To instruct the Ministers of Finance and of Transportation and Road Safety to increase the State's participation in Israeli airline security costs to 75%, immediately after the signing of a global aviation agreement with the European Union ("Open Skies") in accordance with Government Resolution 441 dated September 12, 2006. c. To instruct the Minister of Transport and Road Safety to report to the Government, six months subsequent to this resolution, on the progress of negotiations with the European Union regarding the global aviation agreement ("Open Skies"). d. Prior to the approval of the 2009 budget, the Budget Controller at the Ministry of Finance will act to submit a budget addition deriving from this resolution for the Government's approval, for the funding for an increase in the State's participation in civil aviation security costs. e. The airlines will act to conduct "exchange purchases" in Israel, as much as is possible at rates agreed upon with the Industrial Cooperation Authority.
On May 13, 2009 the Company filed a revised petition, in which the Company requested that the original 2008 government decision to be implemented, or alternately, until the August 2008 cancellation resolution.
After the 2009 State Budget passed in July 2009 and until the balance sheet, the Company received an accumulated sum of $10 million from the State of Israel for participation in security expenses for 2009. This sum reflects the Government Resolution passed on February 1, 2009, according to which starting at the beginning of 2009 the Israeli airlines' participation in security costs shall be reduced from 50% to 40%. The added Government participation in these security expenses has been recognized in the 2009 Statement of Operations being offset from the security expenses borne by the Company in this period.
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Note 18 - Short Term Borrowing and Current Maturities a. Composition:
As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Current maturities of long-term bank loans 145,324 77,813 Current maturities of other loans (1) 972 - Bank overdraft 1,291 28,203 Total 147,587 106,016
Annual interest (in %) 0.3-4.0 0.3-4.9
(1) In principle due to commitments to make capital leases for IT equipment. b. Liens and collateral – see Note 41.
Note 19 - Trade Account Payables a. Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Open accounts 152,379 120,601 Airlines 5,533 8,369 Total 157,912 128,970 b. The average credit period granted as a result of goods purchasing is 45 days (2009: 48 days), for which the Group does not pay interest.
Note 20 - Other Payables
a. Current Liabilities
Composition: As of December 31 2010 2009 Thousands of Dollars
Airport fees and taxes payable 25,119 24,324 Interest payable on long term loans 2,190 2,646 Deposits received for passenger groups 3,390 6,804 Payables due to cargo claims (see Note 27.c.b.1) 3,163 3,072 Other payables 15,763 17,598 49,625 54,444
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b. Non-Current Liabilities
Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Payables due to cargo claims (see Note 27.c.b.1) 6,263 9,090 Lease incentives (see Note 29.d.2 as well as 26.c) 4,437 4,228 10,700 13,318
Note 21 - Linkage Conditions – Liabilities
Current liabilities- division by linkage conditions:
As of December 31 2 0 10 2 0 0 9 Thousands of Dollars Monetary liabilities: In USD or linked 290,852 284,850 In Israeli currency (NIS) 164,538 155,895 In Euros or linked 29,516 27,560 Other foreign currency or linked 16,198 15,364 501,104 483,669
Non-monetary Liabilities 231,204 204,444
Total 732,308 688,113
Non-current liabilities- division by linkage conditions:
As of December 31 2 0 10 2 0 0 9 Thousands of Dollars Monetary liabilities: In USD or linked 594,899 745,441 In Israeli currency (NIS) 56,529 52,035 In euros or linked 675 893 Other foreign currency or linked 5,010 5,113 657,113 803,482
Non-monetary Liabilities 84,259 56,126
Total 741,372 859,608
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Note 22 - Long-Term Loans from Financial Institutions
a. Composition:
As of December 31 2 0 10 2 0 0 9 Thousands of Thousands of Dollars Dollars
Dollar bank loans at variable interest 619,313 686,707 Dollar bank loans at fixed interest 99,103 108,541 Less: current maturities (146,296) (77,813) 572,120 717,435
Less – balance of loan arrangement costs (11,036) (13,241) 561,084 704,194
Yearly interest (in %) 0.3-4.0 0.3-4.9
b. Loan arrangement costs: Accumulated Cost Amortization Depreciated Cost Thousands of Thousands of Thousands of Dollars Dollars Dollars
As of January 1, 2010 25,332 (12,091 ) 13,241 Yearly additions - (2,205) (2,205) As of December 31 2010 25,332 (14,296) 11,036
c. Repayment Dates as of December 31 2010:
Thousands of Dollars
First year * 146,296 Second year 138,273 Third year 174,570 Fourth year 35,748 Fifth year and thereafter 223,529 718,416 Less: current maturities (146,296) 572,120
* See Note 22i below.
d. Additional information:
1. For the financing of the purchase of aircrafts (including via subleases as denoted in Notes 16.d.1 and 16.d.2 above) and spare engines, between 1999 and 2007 the Company received bank loans totaling $1,057 million at variable interest of LIBOR plus a margin, repayable between 1999 and 2019.
2. For financing most of the cost of the 747-400 aircraft (marked ELE) from Singapore Airlines, in November 2008 the Company received a $36 million loan from a foreign bank for an 8-year
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period, with semiannual principal and interest payments. The loan bears variable Libor interest plus a margin.
3. To finance the three 737-800 aircraft (marked EKH, EKJ and EKL) received in April, May and June 2009, through a sublease as stated in Note 16.d.3, the Company received three loans from a foreign bank to the amount of $37.5-$38 million per loan. The loans are for a period of 12 years and bear fixed interest of 3.62%, 3.62% and 4.01%, respectively. The loans shall be repaid in 48 quarterly payments, principal and interest, on fixed dates each year.
e. As for hedging transactions to fix variable interest rates – see Note 31.f.
f. Early repayment:
All existing loans as of December 31, 2010 may be repaid early by the Company. Moreover, in accordance with the terms stipulated in certain agreements, if, in the opinion of the bank, based on reasonable criteria, an event has occurred that adversely affects the Company’s financial position or its business or its financial ratios in a manner endangering or potentially endangering its ability to repay any bank financing, then the bank may demand the immediate repayment of the credit balance it provided.
g. Restrictions and financial covenants of long-term loans:
1. Ratio between loans balances and collateral-
Some loan agreements described in items d.1 - d.3 above stipulate that the market value of the pledged aircraft should exceed the bank-loan balance by 25% and that such an examination should be conducted once a year (in some agreements – twice a year) based on certain predetermined international professional publications. The Company has also undertaken that should the actual ratio be lower than the above ratio, the Company will provide additional collateral, or repay its bank loans earlier, in order to fulfill the ratio requirement. The Company has provided aircrafts in its possession as additional collateral for loans taken by the Company to finance its aircraft fleet; for further details, see Note 41.
Due to the difference between the credit and the balance of securities created as a result of the drop in aircraft prices in October 2009, in June 2010 an agreement was signed between the Company and a banking corporation, according to which the bank shall provide a waiver, with its advance consent, for a two-year period due to the collateral gap created by the impairment of securities to a sum of $30 million. A balance of collateral above that sum shall be grounds for the immediate repayment of the loans secured by the collateral. Furthermore, it was agreed that the Company would pay the bank a commission due to the colateral gap between the aircraft's value and the debit balance, calculated and paid on each date an aircraft value price list was published. As of the publication of the last price list, the Company was not required to pay any commission in accordance with the agreement in question.
2. Arrangement with banks prior to privatization –
In 2004, management requested that BLL agree that the transfer of control to K’nafaim would not give the BLL the right to demand immediate repayment. In this regard, BLL informed the Company that it had no objection to the change of control in the Company whereby K’nafaim would increase its holdings in the Company in a manner that would cause it to be the controlling party in the Company.
BLL’s consent is contingent upon the fulfillment of the following conditions:
1. The controlling parties in K’nafaim would be the Borowich family. The term “control” for this purpose is as defined in the Banking Law (Licensing), 1981.
2. The change in ownership referred to above would take place no later than June 5, 2007.
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Subject to the above, it was agreed that BLL would not exercise its right to demand immediate repayment of outstanding debts and liabilities of the Company solely as the result of the abovementioned change in control. Moreover, within this framework, K’nafaim informed BLL that, in light of the Company’s present outstanding debt to BLL, and due to the fact that the Company’s Board of Directors will, from time to time, formulate a profit distribution policy for the Company, then as long as the open principal balance of the outstanding debt of the Company to BLL is not less than $50 million, K’nafaim will not support a resolution for profit distribution at a rate exceeding 60% of distributable retained earnings of the Company from time to time, unless following consultation with BLL regarding any amount in excess of 60%. In 2007, the Company approached BLL for a consultation on the distribution of dividends exceeding this rate.
h. Liens and collateral – see Note 41.
i. Repayment Balance of Loans from Financial Institutions
The repayment date of a loan from a financial institution to the amount of $60,000 thousand will apply in August 2011. This sum is presented in the December 31 2010 Financial Statements under Current Liabilities under Short-Term Borrowing and Current Maturities. The Company is in advanced stages of talks with the financing banks to redeployment the an eliminated balance of the loan over an extended period. The repayment date of a loan from a financial institution to the amount of $4,000 thousand will apply in April 2011. This sum is presented in the December 31 2010 Financial Statements under Current Liabilities under Short-Term Borrowing and Current Maturities. The Company is in advanced stages of talks with the financing banks to the an eliminated balance of the loan over an extended period.
Note 23 - Obligations Deriving from Employee Benefits
a. Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Post-employment benefits within the framework of defined benefits plans: Retirement benefits 2,232 2,720 Liability due to retirement and severance pay (34,342 ) (30,147) Pension funds 6,099 6,539 Redeemed sick pay 39,523 35,468 13,512 14,580 Other long term employee benefits Benefits due to anniversary grant 1,174 1,078 Other 3,167 *2,332 4,341 3,410 Termination benefits At-will retirement plans 10,121 14,350 Less current maturities (1,183) (1,007) 8,938 13,343 Short term employee benefits: Wages, salaries and social benefits 45,198 32,799 Vacation and rest days 53,514 48,580 98,712 81,379 Presentation in balance sheet: Assets due to employee benefits: Non-current, net 38,799 34,501 38,799 34,501
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As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
Employee benefits obligation: Current 98,712 81,379 Non-current, net 65,590 65,835
164,302 147,214
b. Division by Linkage Conditions
As of December 31 2010 As of December 31 2009
In or Linked In or Linked to Foreign In NIS, Non- to Foreign In NIS, Non- Currency Linked Currency Linked Thousands of Dollars Thousands of Dollars
Post-employment benefits within the framework of defined benefits plans: 10,756 2,756 11,882 2,698
Other long term employee benefits 2,599 1,742 1,800 1,610 Termination benefits - 8,938 - 13,343 Short term employee benefits 1,097 97,615 1,133 80,246
Total employee benefit obligations 14,690 110,769 14,815 97,897
c. Post-Employment Benefits:
(1) Defined deposit plans
Retirement and Severance Compensation Plans
Israeli labor and severance compensation laws require that the Company and subsidiaries pay compensation to employees upon retirement or dismissal. The calculation of liability as a result of the termination of employee-employer relationships is carried out in accordance with the valid employment agreement and is based on the employee's salary which, in management's opinion, creates the right for compensation.
The Company and its subsidiaries have approval from the Ministry of Labor and Welfare in accordance with Section 14 of the Severance Pay Law 1963, according to which its current deposits in pension funds and insurance policies exempt it from any additional obligations towards its employees, for whom the aforementioned sums were deposits. The Group shall have no legal or implied obligation to make additional payments if the plan has insufficient assets to pay for all employee benefits pertaining to the employee's service in the current and in previous periods.
The total sum of expenses charged to the Statement of Operations for defined deposit plans in the year ending December 31, 2010 is $12,926 thousand (2009: $11,858 thousand, 2008: $9,793 thousand).
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(2) Defined Benefit plans
a. General:
Severance and Retirement Compensation Obligations
Israeli labor laws and the Severance Pay Law require that the Company and its subsidiaries pay compensation to employees upon dismissal or retirement (including employees departing from the workplace under other specific circumstances). The calculation of the liability for the discontinuation of the employer-employee relationship is carried our in accordance with the valid employment agreement and is based upon the employee's last salary payment, which, in management's opinion, creates the right to receive compensation, taking his years of employment into consideration.
The obligation in question was calculated using actuary tables. Actuary estimates were also conducted by Ogen Ltd., a member of the Israeli Actuary Association. The present value of a defined benefit liability and the costs relating to current service and past service were measured using the Forecast Entitlement Method.
b. Pension agreement-
The social benefits of some of the Company employees have been formalized in a pension agreement. The pension agreement, signed on September 1, 1992 between the Company, the Histadrut, representatives of employees and the Mivtachim pension fund, is based on the industrial pension agreement that was adapted for the particular structure of the population of Company employees.
Membership in the comprehensive pension plan was previously voluntary for veteran employees and mandatory for new employees to whom the collective labor agreement applied and who were able to accumulate the qualification period for entitlement to a pension. (Veteran employees with an age exceeding 55 for men and 50 for women could, under certain conditions, join a comprehensive pension plan and receive a pension even without having completed 10 years of membership.) An employee joining the comprehensive pension must insure part of his salary by pension (ground worker - 50%, flight-crew personnel - 25%) and the balance can be covered by managers' insurance or the provident fund for Company employees.
The agreement provided that the Company's payments to the pension fund and an approved fund (executive insurance or provident fund) for an employee joining the pension plan, will, for all intents and purposes, come in lieu of its severance-pay obligation for that employee, pursuant to Section 14 of the Severance Pay Law for that part of the salary and for that period as to which the payments were made. The employees joining the pension plan are entitled to severance pay and provident fund pay upon retirement from work, for the period beginning with commencement of employment through the date of joining the pension fund and, subsequently, to the rights accrued to their credit in the pension fund.
Starting January 1, 1995, new employees are insured for pensions with the Mivtachim comprehensive pension plan, according to the pension rules to new members. The retirement age was increased, in effect starting 2004.
(3) Severance pay
a. General:
Employees who received tenure by September 1992 are entitled to severance pay for their employment until then, computed on the basis of one month for each year of employment. With regard to the employment period thereafter, the abovementioned employees are entitled to severance pay if they have not joined a pension plan, or a combined plan of pension, managers' insurance and savings in a provident fund (at their personal election) according to the rules prescribed in the collective labor agreement. Employees who subsequently received permanent status in the Company were then obligated to join the pension plan by selecting the appropriate pension combination, but are not entitled to severance pay. Prior to the privatization date, the Company had concluded arrangements with the employees for assuring severance pay and with the State of Israel to assure financing sources. See item b. below. - C 53 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
b. Arrangements with the employees for assuring severance pay and with the State of Israel to assure financing sources:
On June 3, 2003 the Company reached an agreement with the employees' representatives for covering the deficit of NIS 516,240 thousand (“the Deficit”) in the obligation for termination of employee-employer relationships, with this amount linked to the CPI and bearing annual interest of 5.05% starting June 1, 2003, net of the amounts transferred to a recognized pension fund, from time to time. After the Company and the State made the above deposits in 2007, the Deficit, as defined in the agreement between the Company, the State and the employees' representatives signed on the eve of the privatization, was covered in full. Any proceeds received by the Company from the exercise of options (Series 1) were deposited in the severance-pay fund of eligible employees, except for 30.4 million NIS (including interest accrued as of the report date) not deposited, which is included in the short-term deposits item as of December 31, 2010. In 2007, the Company contacted the Controller-General in the Ministry of Finance on the matter. As of this report, the Controller-General has yet to issue his response in the matter of the Company's right to make use of the above proceeds. In the December 31, 2010 Financial Statements, this deposit is presented against an obligation to the State of Israel, until the Company's rights as regards these funds is resolved.
(4) Redemption of Sick Leave
Pursuant to the collective labor agreement, employees are eligible for full payment of up to 30 days' illness per annum (other than new employees who have limited accumulation), which may be accrued throughout all years of employment. Upon retirement from the Company, in mandatory retirement or retiring after attaining the age of 45, permanent employees (other than executives, beginning from their transition to personal employment contracts) are entitled, if they retired under terms entitling them to severance pay, to receive a grant for unutilized sick days, at a rate of up to 26.6% of the value of the unused days. The liability for this grant was determined on the basis of the rights accrued for those eligible employees who reached the age of 45 as of the date of the Financial Statements.
(5) Temporary Employees
Pursuant to the labor agreement signed by the Company and the temporary employees, these employees have joined the comprehensive pension plan, and the Company deposits monthly amounts for them on a current basis. These deposits cover the Company’s obligations for the termination of employee-employer relationships for its temporary employees. As regards the special collective labor agreement signed between the Company's employees, the workers' representatives and the Histadrut – see Note 23.c.(13) below.
(6) Flight-Crew Personnel
Air-crew personnel are entitled, according to an agreement, to receive severance pay for their period of employment through December 1979, computed on the basis of their last salary, or their salary for the month of December 1979 (net of the part of the salary for which severance pay had been paid in the past - 20%), linked to the Israeli CPI, whichever is higher. As for the period subsequent to December 1979, the Company's liability for severance pay is computed on the basis of their last salary. As to the lawsuit filed as a result of the change in retirement ages – see Note 27.c.(c).4 below.
(7) Company Executives
Company executives are employed via personal employment agreements. These employees are entitled to receive additional severance pay for the period of their employment of 100%, in excess of the balances accumulated in the pension funds and/or insurance companies.
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(8) Employees Posted Abroad
Among the Company employees abroad are permanent workers who are Israeli residents, relocated to fill managerial positions abroad, usually for periods ranging from four to six years ("Posted Employee"). Salaries of the posted employees while serving abroad ("Compensation Abroad") are different from Israeli wages, and take into account the local standard of living and taxation, and the fact that the salary is subject to income tax and social deductions both abroad and in Israel. In addition to the salaries of the posted employees, the Company bears the cost of their housing and tuition fees for their children. Salaries payments including rent and tuition are paid by the Company subject to Israeli income tax regulations. As for the income tax authorities' claim regarding deductions – see Note 28f below. Benefits after the termination of employee-employer relationships for those employees are determined on the basis of wages paid to employees at their level that they are employed in Israel.
(9) Local Employees in Company Branches Abroad
Most Company employees abroad, other than the Israeli posted employees, are engaged under collective labor agreements between the Company and the union in that country, or under employment agreements with the employees’ representatives, with a few under agreements between the employers' organization (foreign airlines) and the umbrella organization of airline employees, or under other agreements. The employment terms of Company personnel in certain countries are not covered by a collective agreement but rather stipulated by the Company, in accordance with the acceptable practice in the airline industry or the national airlines in those countries. In some branches, the employees are engaged under personal contracts or through a contractor.
Some of the branches are committed to pay severance pay according to law or agreement while others are obliged to adhere to national or other pension insurance. The Company transfers regular payments for the pension insurance.
Some of the local Company employees who are residents of the U.S. and the U.K benefit from pension plans ("the Plans"), with the pension costs of the branch employees being paid by the Company. The cost of the pension is computed as a multiple of the "years of eligibility" for the pension multiplied by the rate of salary determined as entitled to pension. Retirement commencing at the age of 65 ordinarily entitles the employee to full benefits. The pension plan assets, which are invested mainly in marketable securities, are not owned by the Company. The Company is obliged to cover any deficit that would be created in the value of the funds’ assets relative to any actuarial obligation, should such deficit be created.
(10) Security Personnel
Payments to discharge obligations for termination of employee-employer relationships related to personnel employed by the Company or by a governmental entity to protect the Company's services are made out of the State budget for aviation security. There is no employee-employer relationship with the Company for most of these employees and, accordingly, no provision was included in these financial statements to cover such payments.
(11) Employees of Subsidiaries
Employment terms of the Company's main subsidiaries in Israel are regulated by labor agreements, pursuant to which the obligation for termination of employee-employer relationships is computed on the basis of their last salary and of pension arrangements, as applicable. The employment terms of the main foreign subsidiaries are regulated by collective labor agreements in those countries and in accordance with local laws and practices.
(12) Collective Agreement
On November 2, 2008 a collective agreement was signed by the Company, the employees' representatives and the Histadrut ("the Agreement") following the Board of Director's approval of the Agreement on October 27 2008. The primary points of this agreement are as follows:
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- The Agreement shall be in effect until December 31, 2012.
- Industrial peace and discipline - a commitment exists to uphold industrial peace for the duration of the agreement, while focusing on competition and growth challenges. The Company, the Histadrut and the employees' representatives shall conduct joint activities to promote and maintain order and discipline in the Company. The Company's authority as regards the termination of employees guilty of severe disciplinary violations shall be expanded.
- Bonuses and pay raises – when the Company becomes profitable, a general pay raise shall be granted equal to 3% of their pension salaries. In the event of profits greater than $10 million, employee shall receive a one-time bonus equal to between 18% and 24% of their base salaries. In addition, in the following year, if the Company earns over $10 million, an addition raise equal to 1% of pension salaries shall be granted. If the Company earns over $35 million, an additional 0.5% shall be added to salaries. In the following year, if the Company earns over $10 million, an additional 1% shall be added to pension salaries. If the Company earns over $35 million an additional 0.5% shall be added.
- Horizon promotion bonus – when the Company becomes profitable, an annual budget for the financing of a horizon promotion bonus for non-promoted ground personnel as well as for flight crews and flight attendants with similar status. Non-promoted employees are workers who have spend many years at the top step of the existing standard pay scale and are not designated for promotion.
- Work cessation – initiated retirement and/or work cessation of 30 employees via a process including work cessation pathways using an increased compensation format, early pension or a choice between the above (in accordance with the retiring worker's age).
- Shifts and rest periods – shifts in Israel stations and maintenance shall be adjusted and reinforced according to activity loads. Rest periods for pilots and regular and temporary flight attendants in North America shall be shortened.
- Special tracks and promotion – temporary employees with more than 3 years seniority may participate in bids for entry-level managerial positions. The Company shall be permitted to employ up to 40 employees via personal contracts. Employees in the flight technical field shall receive tenure after their fourth year instead of their second.
In September 2010 the Company signed a collective agreement with the New General Workers’ Histadrut, Professional Union Branch – Transportation Workers Union, the Pilots’ Union, via representatives of the El Al pilots’ sector, dealing in various agreements pertaining to the Company’s flight crews including the operation of a Boeing 747-200 cargo plane, extending the pilot transfer period from one fleet to another and so on.
(13) Special Collective Agreement Regarding the Employment of Temporary Personnel (“the Temp Agreement”)
The terms of employment of temporary employees have been arranged in a special collective agreement that, on May 20, 2004 was extended to December 31, 2008. The agreement stipulates the maximum length of employment of temporary employees, in accordance with the type of work and the department in which the worker is employed. The agreement regulates all of the terms of employment of temporary employees, including wages, bonuses, provisions for comprehensive pensions, insurance, sick leave, rights to airline tickets, etc. The agreement was extended as part of the Special Collective Agreement on November 2 2008 to December 31, 2012. As special collective agreement pertaining to temporary flight attendants and temporary employees in the administrative sector was signed in February 2011. According to the agreement, a special reserve of 150 employees from each sector shall be established, who shall remain employed for an additional period of ten years as temporary employees. The working conditions of these employees shall be equivalent to full- time second generation workers, with the exception of the education fund. These employees shall adhere to the second generation employee disciplinary code. Dismissal of such employees due to incompatibility shall be via a consensual on par committee or following arbitration. The agreement shall be in effect for three years with the option of extending it by an additional two.
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(14) Chief Actuary Assumptions as of the Balance Sheet Date: As of December 31 2010 2009 2008 % % %
Discount rate 4.2% 5.1% 5.3% Projected yields on the plan's assets 4.2% 5.1% 5.3% Projected salary increase rates 3.7% 3.7% 3.7% Replacement and departure rates: Up to 39 years of age 5.0% 5.0% 5.0% Between the ages of 40 and 49 3.0% 3.0% 3.0% Between the ages of 50 and 54 2.0% 2.0% 2.0% Between the ages of 55 and 59 1.0% 1.0% 1.0% Between 60 and retirement 0.5% 0.5% 0.5%
Assumptions regarding future death rates (including reductions in future death rates) are based on statistical data published by Ministry of Finance Circular 3-6 2007 from May 2007. The Group makes use of a discount rate appropriate to the market's yields from government bonds.
In the event that use is made of the discount rate of corporate bonds, this is expected to have a material impact on the Group's Financial Statements. A decrease shall occur in the sum of the defined benefit plan to the amount of $13,188 thousand (2009: $12,398 thousand, 2008: $13,225 thousand) as well as a $1,066 thousand increase in employee benefit plans (2009: $1,002 thousand, 2008: $1,004 thousand).
(15) Sums Recognized in the Statement of Operations for Defined Benefit Plans:
For the Year Ending December 31 2 0 10 2 0 0 9 2 0 0 8 Thousands of Dollars
Current service cost 8,167 7,572 7,022 Interest cost 11,794 11,382 12,435 Projected yield on the plan's assets (11,352 ) (9,055) (12,815) Real yield transferred from compensation to remuneration 273 667 496 Adjustments due to ceiling for recognition of asset due to defined benefit plan - - 774 Exchange rate differences 10,155 (256 ) (1,881) Deviation from strip 815 2,063 - Changes in the period (576) - - 19,276 12,373 6,031
The expense was included in the following items: Operating expenses 15,479 8,940 4,316 Selling expenses 1,079 1,600 799 General and administrative expenses 2,718 1,833 916 19,276 12,373 6,031
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(16) Movement in the Current Value of Obligation due to Defined Benefit Plan:
For the Year Ending December 31 2 0 10 2 0 0 9 Thousands of Thousands of Dollars Dollars
Opening balance 222,916 212,398 Current service cost 8,167 7,572 Interest cost 11,794 11,382 Actuarial losses 11,776 1,363 Changes in the period (576) Benefits paid (13,560) (12,582) Exchange rate changes 10,155 2,783 Closing balance 250,672 222,916
(17) Movement in the Fair Value of the Plan's Assets:
For the Year Ending December 31 2010 2009 Thousands of Thousands of Dollars Dollars
Opening balance 202,370 159,723 Projected yield on the plan's assets 11,352 9,055 Actuary gains 9,784 34,739 Employer’s contributions 7,100 10,143 Benefits paid (10,511) (13,663) Real yield transferred from compensation to remuneration (273) (667) Exchange rate changes 10,849 3,040 Closing balance 230,671 202,370
(18) Adjusting the current value of the commitment for the defined benefit plan and the fair value of the plan's assets to assets and liabilities recognized in the balance sheet:
As of December 31 2010 2009 Thousands of Thousands of Dollars Dollars
Present value of funded obligations 202,636 180,696 Less - fair value of the plan's assets (230,671) (202,370) (28,035) (21,674) Current value of unfinanced liability 48,036 42,220
Net unrecognized actuary losses (6,489) (5,966) Net asset/liability deriving from defined benefit commitments 13,512 14,580
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(19) Composition of the plan's assets: Fair Value of the Plan's Assets as of December 31 2010 2009 Thousands Thousands of Dollars of Dollars
Shares 86,270 30,356 Government bonds 36,590 68,806 Corporate bonds 60,245 48,569 Cash, cash equivalents and deposits 27,069 15,139 Other investments 20,497 39,500 230,671 202,370
The total projected yield rate is the weighted average of the projected yields of all types of assets constituting the plan's assets as detailed above. The projected yield rate for the plan's assets in the reported year is 4.2% (in 2009: 5.1% and in 2008: 5.3%).
(20) Actual Yield from the Plan's Assets and Compensation Rights:
For the Year Ending December 31 2010 2009 Thousands of Thousands of Dollars Dollars
Projected yield on the plan's assets 11,352 9,055 Actuary gains 9,784 34,739 Actual yield on the plan's assets 21,136 43,794
(21) Actuary Gains/Losses Not Yet Recognized: For the Year Ending December 31
2010 2009 2008 Thousands of Dollars
Actuary gains (losses) not recognized as of January 1 (5,966) (42,575) 15,670 Actuary gains (losses) created in the current period for the liability and due to plan assets (1,991 ) 33,376 (58,017 ) Deviation from strip 815 2,063 - Exchange rate changes 653 1,170 (228) Actuary losses not recognized as of December 31 (6,489) (5,966) (42,575)
d. Other Long-Term Employee Benefits:
(1) General
Employees reaching 20, 30 and 40 years of seniority at the Company are entitled to a gift granted during the yearly “decades ceremony” held by the Company.
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(2) Chief Actuary Assumptions as of the Balance Sheet Date
As of December 31 2010 2009 % %
Discount rate 4.2% 5.1% Projected salary increase rates 3.7% 3.7% Replacement and departure rates: Until 39 years of age 5% 5% Between the ages of 40 and 49 3% 3% Between the ages of 50 and 54 2% 2% Between the ages of 55 and 59 1% 1% Between 60 and retirement 0.5% 0.5%
In order to capitalize the liability the Group makes use of a discount rate appropriate to market yields from government debentures.
(3) Sums Recognized in the Statement of Operations for Long Term Employee Benefits:
For the Year Ending December 31 2010 2009 2008 Thousands of Dollars
Current service cost 64 199 74 Interest cost 56 174 81 Actuary gains (losses) recognized in Statement of Operations 20 621 (430) Exchange rate changes 104 (372 ) 15 Changes in the period 799 53 1,044 675 (260)
The expense was included in the following items: Cost of goods sold 838 542 (231 ) Selling expenses 58 38 (9 ) General and administrative expenses 148 95 (20) 1,044 675 (260)
(4) Movement in the Current Value of Obligation due to Other Long Term Employee Benefits:
For the Year Ending December 31 2010 2009 Thousands of Dollars
Opening balance 3,410 3,210 Current service cost 64 51 Interest cost 56 45 Actuary gains (losses) recognized in Statement of Operations 20 160 Benefits paid (112) (123) Changes in the period 799 53 Exchange rate changes 104 14 Closing balance 4,341 3,410
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e. Termination Benefits:
(1) General Between 2000 and 2010, the Company's management adopted resolutions relating to early retirement programs for 703 employees, for which provisions were recorded in the Company's accounts. As of December 31, 2010, all the employees (with the exception of 11 workers) had concluded their actual retirement from the Company within the framework of the abovementioned programs. The retirement plans include 11 employees, for whom decisions were reached by Company management during 2010, and for which a provision of $2 million was recorded in the December 31, 2010 Financial Statements (see Note 32.e.2). The December 31, 2010 Financial Statements include the balance of an accrual in a total amount of $34.8 million for financing the retirement of approximately 354 employees, (after a group of employees included in the original retirement programs reached retirement age by December 31 2010, with a provision no longer recorded for them in the financial statements). Within that framework the Company deposited funds for assuring early retirement pension payments to employees. The balance of the deposits as of December 31, 2009 amounted to $24.6 million. The total net provision for retirement plans as of December 31, 2010 is $10.1 million. As part of the Company's privatization, the State of Israel provided guarantees, to uphold the Company's commitments, in favor of Mivtachim with respect to the retirement programs, which amounted as of December 31, 2010 to a total of approximately $8.5 million. As the Company formulates and decides upon consensual retirement programs in the future, subject to the cooperation of the employees’ representatives, the Company will not be entitled to receive additional guarantees from the State of Israel. Additional retirement programs will be executed with Company guarantees.
(2) Composition of the Balance Sheet Balance: As of December 31 2010 2009 Thousands of Thousands of Dollars Dollars
Termination benefit obligation 34,757 41,191 Assets of plan to finance obligation (24,636) (26,841) 10,121 14,350
(3) Presentation in Statement of Operations: For the Year Ending December 31 2010 2009 2008 Thousands of Dollars
Other expenses 5,106 1,289 9,084
(4) Chief Actuary Assumptions as of the End of the Reported Period: As of December 31 2010 2009 % %
Discount rate 4.2% 5.1% Projected yields on the plan's assets 4.2% 5.1% Projected salary increase rates 3.7% 3.7% Replacement and departure rates: Up to 39 years of age 5% 5% Between the ages of 40 and 49 3% 3% Between the ages of 50 and 54 2% 2% Between the ages of 55 and 59 1% 1% Between 60 and retirement 0.5% 0.5%
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Assumptions regarding future mortality rates are based on a mortality table published by the Capital Markets, Insurance and Savings Branch of the Ministry of Finance in Memo 2007-3-6 dated May 2007. The average projected life span for a man retiring at the age of 67 is 82 years and for a woman retiring at age 64 is 85 years.
In order to capitalize the liability the Group makes use of a discount rate appropriate to market yields from government debentures.
f. Short-Term Employee Benefits:
(1) Paid Vacation Days
According to the Yearly Vacation Law, 1951, Company employees are entitled to a number of paid vacation days for each work year. In accordance with the law in question and an amendment thereof established in the agreement between the Company and its employees, the number of vacation days to which each employee is entitled is determined based on the employee's seniority.
Employees are entitled to 22 vacation days per year (with the exception of a minority entitled to 30 days per year), and to accrue the balance of unused vacation days. Vacation days are first used from the current year's allotment and later from a balance passed forward from the previous year (on an LIFO basis). Employees who have left the Company prior to making use of the balance of their accrued vacation days are entitled to payment for the balance of these vacation days upon leaving.
(2) Composition As of December 31 2010 2009 Thousands of Thousands of Dollars Dollars
Wages, salaries and social benefits 45,198 32,799 Vacation and rest days 53,514 *48,581 Total 98,712 81,380
*Reclassified
g. Further Information - Related Parties
For information on current employee benefit obligations granted to related parties see Note 38.
Note 24 - Unearned Revenues
a. Current Liabilities
Composition: As of December 31 2 0 10 20 0 9 Thousands of Thousands of Dollars Dollars
From the sale of flight tickets 199,626 175,127 For frequent flyer points 31,366 29,106 Others 212 211
231,204 204,444
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b. Non-Current Liabilities
Composition: As of December 31 2 0 10 2 0 0 9 Thousands of Dollars
For frequent flyer points 51,467 50,813
Note 25 - Derivative Financial Liabilities
a. Composition
Current Liabilities Non-Current Liabilities Total As of December 31 As of December 31 As of December 31 2010 2009 0201 2009 2010 2009 Thousands of Dollars
Derivative financial instruments designated as hedging items Interest rate swap agreements 300 2,659 - 899 300 3,558 Jet fuel hedging agreements - 51,447 - 361 - 51,808 300 54,106 - 1,260 300 55,366 Derivative financial instruments measured at fair value via gain/loss: Interest rate swap agreements 2,029 1,537 19,739 18,875 21,768 20,412 2,029 1,537 19,739 18,875 21,768 20,412
Total other financial liabilities 2,329 55,643 19,739 20,135 22,068 75,778
b. Repayment Dates as of December 31 2010 Thousands of Dollars
First year 2,329 Second year 19,739 22,068
* Splitting interest rate swap agreements between current and non-current liabilities is carried out in accordance with the contract’s final clearance date with the hedging bank. Regarding expected non capitalized cash payments for interest rate swap agreements, see Note 32.j.2.
c. Additional Information
Regarding liens – see Note 41. Regarding deposit pledged from jet fuel hedging transactions, see Note 5b.
Note 26 - Operational Lease Arrangements
(1) General
The Group entered into operational lease arrangements for aircrafts which as of the balance sheet date extended to periods of between 5 months and 6 years, which include an extension option for up to 3 additional years. The Group does not have an option to purchase the leased assets at the end of the lease period. In addition, the Company has a lease agreement with the Israel Airport Authority (see Note 29.d.2).
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(2) Payments Recognized as Expenses For the Year Ending December 31 2010 2009 Thousands Thousands of Dollars of Dollars Aircrafts leases 64,147 53,641 Land usage rights 1,581 2,208 65,728 55,849
(3) Commitments for Minimal Future Leasing Payments for Non-Revocable Operational Leases
As of December 31 2010 2009 Thousands Thousands of Dollars of Dollars
2010 - 40,552 2011 47,867 26,476 2012 37,304 18,558 2013 30,786 15,207 2014 onward 89,693 63,191 205,650 163,984
Minimal leasing fee obligations do not include payment for maintenance reserves for operational aircraft leases. Regarding minimal future lease payment liabilities for non-revocable operational leases, the Group recognized the following liabilities: As of December 31 2010 2009 Thousands of Dollars Leasing incentives (see Note 29.d.2)
Presented under other payables – non-current 4,437 4,228
Note 27 - Provisions
a. Composition Total As of December 31 2010 2009 Thousands of Dollars
Provision to salaries and institutions (see Note 28f) 27,114 43,242 Legal proceedings (see c.) 5,493 1,511 The State of Israel (see Note 23.c.3.b) 8,565 7,933 Other 3,767 4,531 Total provisions 44,939 57,217
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b. Movement: Provisions to Salaries Cargo and Legal Claim The State Institutions Proceedings Provision of Israel Other Total Thousands of Dollars
Balance as of January 1 2009 38,736 3,493 15,427 7,821 3,300 68,777 Additional provisions recognized 1,438 873 - 54 1,231 3,596 Updating existing provisions 3,067 753 - - - 3,820 Sums used during the period (334) (823) (3,265) - - (4,422) Sums cancelled during the period - (2,784) - - - (2,784) Classified to other payables - - (12,162) - - (12,162) Exchange rate influence 335 (1) - 58 - 392 Balance as of December 31 2009 43,242 1,511 - 7,933 4,531 57,217
Balance as of January 1 2010 43,242 1,511 - 7,933 4,531 57,217 Additional provisions recognized 1,164 4,880 - 123 - 6,167 Updating existing provisions 2,015 218 - - - 2,233 Sums used during the period - (1,045) - - - (1,045) Sums cancelled during the period (22,250) (73) - - (764) (23,087) Exchange rate influence 2,943 2 - 509 - 3,454 Balance as of December 31, 2010 27,114 5,493 - 8,565 3,767 44,939
c. Legal Proceedings
As of December 31, 2010, legal claims in a total amount of approximately $151 million had been filed against the Company with respect to which the Company had recorded provisions in its Financial Statements, based on the Company's legal counsel advice, of approximately $7.4 million ($1.9 million of which is under non-current liabilities due to employee benefits). Legal claims non - quantified in monetary amounts have also been filed against the Company. The above provision in the financial statements also includes provisions for non-quantified claims, as estimated by Company management. In the assessment of Company management, based upon the opinions of its legal counsel, it is not anticipated that the Company will be exposed to an additional loss with respect to the abovementioned claims in excess of the above provisions recorded in the financial statements.
The following is a detailed summary of material legal and financial claims:
a) Class actions:
1. Between 1998 and 2009, several class actions were filed against the Company, some of which are quantified and some are not, totaling 391.6 million NIS ($110.3 million as of the balance sheet date) as follows: (1) A claim regarding over-billing for flight tickets by travel agents as a result, allegedly, of the use of incorrect exchange rates. (2) A claim that a travel agent charged a travel fee at a rate higher than legally allowed, that being the representative rate, and that the Company is responsible for the actions of these agents. (3) A claim that charging customers purchasing flight tickets directly (and not through travel agents) using credit cards are charged in foreign rather than Israeli currency, a foreign - C 65 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
currency commission to the amount of 2% of the cost of the ticket (for converting the payment in foreign currency to Israeli currency) to the credit card companies, constitutes a violation of the consumer Protection Law, 1981, a violation of good faith and creation of illicit gains. (4) A claim that the prices collected by the Company for excess baggage in its flights are at excessive rates and are calculated separately from the Company's regular prices. (5) A claim that the claimant's flight from Madrid to Tel Aviv was postponed due to a strike at BGN and that she was not attended to by the Company causing expenses, distress and loss of time. (6) A Claim filed to the New York State Supreme Court. The claimants were charged international conversion fees on their credit cards for the purchase of Company airline tickets in the U.S. using the credit cards of the credit card company sued. (7) A claim that the Company had failed to meet the requirements of Revision 40 to the Communications Law (Telecommunications and Broadcasts) 2008, known as the Spam Law, which forbids the transmission of advertising via email, fax, text message or telephone without the recipient's consent.
All of the claims in question against the Company were dismissed in 2008 and 2009, some by way of a settlement and some by the Company refunding trial costs.
2. In January 2007, a claim was filed against the Company in Jerusalem District Court, together with a motion for recognition as a class action, in the amount of NIS 483.4 million ($136 million as of the balance sheet date. The plaintiffs allege that the collection of a security fee of $8 per flight leg, from passengers in flights that are not flown by the Company itself, but by other airlines under code sharing arrangements, constitutes misleading the consumer, breach of the agreement with him, the absence of good faith and unlawful enrichment, since, the plaintiffs allege, these flights do not provide security services at the same standard and quality as the services provided by the Company. The plaintiffs requested that the Company be required to pay each of these passengers the sum of $8 as well as damages of NIS 500 for emotional distress and loss of benefit. On August 19 2009, the Court rejected the motion in question and ruled the petitioners liable for expenses to the Company. An appeal was filed before the Supreme Court on October 22 2009. In the opinion of Company management, based upon the advice of its legal counsel, the Company is not expected to be found liable in this claim. No provision has been made for this claim in the Financial Statements.
b) Legal proceedings in the field of Restraint of Trade overseas:
(1) In February 2006, the Antitrust Division of the U.S. Justice Department ("Antitrust Division") began an open investigation against several airlines, together with additional competition authorities in Europe and other countries, of alleged suspicion of price fixing with respect to certain increments to prices of air cargo transport. Several cargo transporters announced that they had received Grand Jury subpoenas pertaining to this investigation. On September 27, 2006, the Company received a grand jury order from the Antitrust Division demanding information and documents regarding pricing practices and certain surcharges related to cargo transportation, since early 1999 and through the date of said order. The Antitrust Division has informed the Company that it is under inquiry as a suspect. On May 25 2008 the Company's Board of Directors reached a decision regarding the listing of a provision in the Financial Statements at a capitalized rate of $20 million U.S. for the aforementioned antitrust investigation. The decision was made based on a study of the possibility of a settlement with the U.S. Justice Department and was carried out as a matter of prudence and not as an admission of liability. On January 21 2009 the Company's Board of Directors approved a plea bargain made with the U.S. Justice Department to end the process. Within the framework of the plea bargain, the Company was required to admit that it had violated U.S. antitrust law and was involved in the fixing of one or more price components in the field of air cargo shipping to and from the U.S. in the period between January 2003 and February 2006, and was required to pay a fine of $15.7 million (a capitalized sum of $15.4 million to be paid in several interest-bearing installments across four year period). In addition, the Company undertook
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to continue its full cooperation with the U.S. Justice Department in its investigation. As part of the agreement, the U.S. Justice Department agreed not to file additional charges against the Company or charges against Company employees and executives, past or future (with a few exceptions) regarding violations of U.S. antitrust laws made in the field of airborne cargo transport prior to entry into the plea bargain. A U.S. Federal Court confirmed the decision on February 4 2009.
(2) In December 2006, the Company received a letter from the European Competition Commission ("the Commission") at its Germany office, which contained a request for information in connection with an investigation being carried out by the Commission. The letter noted that the request for information was in the in connection with activities that, allegedly, cause damage to competition in the sector of air transport services for cargo, and that the Commission has information regarding extensive contacts that took place between airlines and other entities with regard to various price increments and other matters such as cargo transport rates. In the context of the letter, the Company was requested to submit data and documentation regarding the Company and its cargo activities, commencing with 1995. The Company has provided its response as requested by the Directorate's letter, while conducting an internal review of its cargo pricing practices. According to publications by the Commission and by several foreign companies, in December 2007 the Commission sent a "statement of objection" to several airlines with regard to the aforementioned inquiry, including claims of alleged breach of competitive statutes of the European Union. The Company has not received the aforementioned letter of claims, and is not among the companies to which the letter of claims was addressed. On November 9 2010 the Commission published an announcement of its decision to fine 11 airlines for a total sum of €800 million for the operation of a global cartel influencing cargo services in the European Economic Area and in particular, for fixing actions pertaining to fuel and security surcharges, in the period between December 1999 and February 2006. The Company was not a recipient of this announcement, and therefore was not found liable and was not fined for this violation.
(3) In February 2007, the Company received a statement of claim filed in a New York court on the matter of the rates for air cargo transport services. In the statement of claim in question, the Company was included as a defendant, along with 38 other airlines, which alleged that the defendants were partners in a conspiracy to fix prices for air cargo transport services, beginning in 2000, while violating competition and other laws in Europe and the United States. The claim was filed in the name of entities that purchase air transport services, directly and indirectly and it also included a motion for class action recognition. The claim includes a request for damages in an unspecified amount as well as additional remedies. The Company joined a mutual defense team featured other airlines being sued. In light of initial settlement talks and based on the advice of its legal counsel, the Company has listed a provision for this claim.
(4) In August 2008, the South Korea Fair Trade Commission (hereinafter: "the Korean Commission") presented the Company with a request for information pertaining to an investigation the Korean Commission is holding regarding possible violations of Korean competitiveness rules in the field of air cargo shipping for the period starting 1999 In February 2009, the Company received a request for complementary information from the Korean Commission. The Company has provided its responses to the requests in question. To the best of the Company's knowledge, the Korean Commission has conducted investigations on a series of airlines. In October 2009, the Korean antitrust authority sent out an "inspection report" to several airlines pertaining to the investigation in question containing claims on the matter of alleged violations of Korean antitrust laws. The Company has not received the inspection report in question and to the best of its knowledge is not numbered among the companies to which the inspection report was addressed. In May 2010 the Korean Fair Trade Commission published a press notice in which it announced its intention to fine 21 airlines in 16 different countries, for an accumulated sum of 119.5 South Korean wons, based on findings regarding involvement in a cartel in the matter of a number of cargo routes to and from Korea. The Company was not a recipient of this announcement, and therefore was not found liable and was not fined for this violation.
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(5) On May 7 2009, the Company received a copy from a motion to approve the filing of a derivative claim and a draft of the claim itself, which were filed before the Tel Aviv-Yaffo District Court. The filing-party, who claims to hold 4,500 Company shares (constituting 0.001% of the Company's equity) has filed a motion that the Court approve the claim as a derivative action against a number of executives serving at the Company in 2003 and who no longer serve in the Company (“the Claim”), based on the argument that these executive allegedly violated their prudence obligation toward the Company by involving the Company in fixing one or more price component in the field of airborne cargo shipping to and from the United States in the relevant period and that, he claims, hey caused damage to the Company estimated at at least $15.7 million U.S., this on the basis of the plea bargain between the Company and the U.S. Department of Justice reported by the Company on January 22 2009. The claim was preceded by a motion to file a derivative claim, which was rejected by the Company after the Company's Board of Directors decided that it would not be in the Company's best interests to file such a claim against former Company executives. The Company filed its response to the motion in September 2009. On August 27, 2009, the executives applied a request to join the action (hereinafter – “the Motion to Join”). The motion to join was rejected by the District Court. After the attempt made by the executives to change the District Court’s ruling by way of a motion to clarify their ruling was not successful, on December 26, 2010 they applied a request to appeal to the Supreme Court in Jerusalem. In February 10, 2011 ruling, the Supreme Court accepted the executives’ appeal and ruled that the motion to join is to be ruled upon by the District Court. A date for a hearing on the motion to join is to be determined. Over the course of these proceedings and prior to the discussion on the request, the claimant passed away. On January 12 2011, the claimant’s representative announced that his heirs have stated their intent to take his place and continue with the proceedings. A date for a hearing on the motion is to be determined.
c) Other Material Legal Proceedings:
(1) In 2008 and 2009 legal proceedings were conducted between the Company and Sabre Inc. (a company registered in the U.S., hereinafter: "Sabre") and between the Company and Sabre Marketing Nederland BV (a Company registered in the Netherlands), regarding the collaboration agreements signed between the companies to the amount of $104.4 million. On October 1, 2009 a series of agreements was in which all disputes and legal proceedings between the parties would be concluded. Accordingly, the commercial agreement at the basis of the joint company – Sabre Israel - was concluded, and on the date of the settlement the Company sold the entirety of its holdings in the joint company (49%) in return for the payment of the Company's share of the joint company's equity and the joint company also repaid the owner's loan granted by the Company, the balance of which equaled a sum of $1.2 million U.S. In addition, The Company and Sabre entered into a new agreement, updating the existing agreement for distribution using the Sabre distribution system, allowing Israeli travel agents connected to this system to work in a full content format. In addition, according to the settlement the Company cancelled charges issued to the joint company for data processing and communications expenses and paid the joint company sums offset in the past by those charges, concurrently with the cancellation of the additional arbitration process beginning in Israel in relation to these sums. As a result of the aforementioned settlement, the Company listed a reduced provision to the amount of $1.7 million U.S. in its Q3 2009 Financial Statements.
(2) In October 2005, a claim was filed in the Supreme Court of Ontario, Canada against the Company and additional defendants by a former employee of the Company for alleged sexual harassment and sexual molestation. The amount of the claim was approximately $2.2 million Canadian (approximately $2.2 million U.S as of the balance sheet date). The Company made a provision for this claim in its Financial Statements, based on the opinion of its legal counsel.
(3) In February 2007, a claim was filed against the Company and other parties in the New York State Supreme Court by an employee of the Company for allegations of sexual harassment by a Company employee in the U.S. In August 2010 a settlement was reached between the parties, in which a monetary sum was paid the claimant.
(4) In June 2006, a suit was filed against the Company and against the State of Israel – Ministry of Finance by 94 claimants who were employed by the Company and took early retirement between
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2001 and 2003. The claimants in their suit have appealed for declaratory relief/order of performance to amend their retirement agreements in a manner in which the retiree will receive the early pension stipend, including fringe benefits, until the legal retirement age, instead of until the age of 65; alternately, the claimants appealed to revoke the retirement agreements. Alternately, the claimants appealed to revoke the retirement agreements. The claimants quantified their claim at 18.2 million NIS (some $5.1 million on the balance sheet date). In January 2009 the court ordered that this claim be consolidated with two additional claims. On January 6 2009 it ruled that the claimants submit their position regarding the limitation of the causes of the claim. On October 14 2010 a partial ruling was issued, stating that early retirement agreements must be reinterpreted, so that instead of 65 years of age they shall be considered valid until 67. The partial ruling also stated that within 60 days of the ruling, basic agreed-upon calculation principles shall be submitted to calculate the sums. Subsequently, the Company filed a request to appeal the partial ruling before the National Labor Court, which was rejected in January 2011. The Company made a provision for this claim in its Financial Statements, based on the opinion of its legal counsel.
(5) In March 2010 a financial claim was filed before the Jerusalem District Court by Mishpacha Newspaper Ltd. and Mishpacha Magazine (2005) Ltd. against a cargo agent and against the Company for a sum of 6.5 million NIS (of which a sum of $1 million is claimed against the Company), featuring claims regarding bills of lading issued for cargo shipments. The Company made a provision for this claim in its Financial Statements, based on the opinion of its legal counsel.
(6) In March 2010 a lawsuit was filed against the Company as part of arbitration proceedings in the U.S. to the amount of $0.7 million on behalf of a hotel that had provided accommodation services to the Company's air crews, which include arguments regarding accounts that require settlement between the parties. The parties have decided to engage in arbitration with the intent of solving the dispute. The Company has made a provision for this claim in its Financial Statements, based on the advice of its legal counsel.
(7) In October 2010 a suit was filed before the Rishon Lezion Magistrate’s Court by the Israel Aviation Authority against the Company to the amount of 1.8 million NIS; in its suit, the IAA claimed that as part of a project for the construction of a new sewage treatment plant in BGN, the Company undertook to construct preliminary facilities and perform sewage treatment up to a specific date, so that the Company facilities may be connected to the new facility. The claim was that the Company had violated its obligations and as a result, the IAA was forced to continue operating old oxygenation ponds, causing it costs and damages. A statement of defense has been filed. The Company made a provision for this claim in its Financial Statements, based on the opinion of its legal counsel.
(8) Following the petition filed in May 2010 by the City of Holon – Head of the Forum of Authorities Surrounding Ben Gurion Airport before the Supreme Court, inter alia against the Minister of Transportation, the Civil Aviation Authority and the Airports Authority (the Company was not listed as a respondent in the claim), an additional petition was filed before the High Court of Justice by the City of Holon – Head of the Forum of Authorities Surrounding Ben Gurion Airport against the Minister of Transportation and Road Safety, the Minister of the Environment, the Airports Authority, the Civil Aviation Authority and the Company, for the issue of an injunction regarding the permit received by the Company in 1998 to perform takeoffs between Thursday and Friday or before holiday eves, during certain hours of the night. The Company and the other respondents (state authorities) have filed their response in which they objected to the petitioner’s petition based on various arguments. Furthermore, hearings were held before a forum of judges on December 23, 2010 and February 8 2011 and the petitioner filed a response to the respondents’ response. Pursuant to this response the petitioner made an offer according to which it would withdraw the petition subject to the statement that the Company would perform no takeoffs at all between 02:00 and 05:00 during summer months and during the winter would only take off during those hours to those destinations to which it intends to return before the beginning of the Sabbath, as close as possible to the hours at the beginning and end of the restriction and with the approval of the Head of the Civil Aviation Authority, who shall provide a copy of his decisions to the petitioner. The court requested that the Company and the other respondents reply to the offer in question. The other respondents replied that the petition should be rejected on the grounds of preliminary
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arguments and on its own grounds, but noted that the Company was the chief interested party in the offer and therefore its reply was needed. The Company submitted a response to the court in which it objected to the petitioner’s offer, inter alia due to the fact that it would worsen the Company’s status relative to permits it has held for many years, to the fact that it is based on incorrect data and due to the fact that the petitioner has not established grounds for the court’s involvement and that the petition should be rejected. The Company estimates that the petition’s acceptance would harm the Company’s flight schedule. Furthermore, the implementation of a decision restricting activity at certain hours, as stated above, of aircraft with certain characteristics in the Company's service, may on the one hand have a negative impact on the Company's operational abilities as regards the operation of various aircraft or various flights, particularly the 747-200, 767-200 and 747-400 fleets in the Company's service and thus impact the Company's ability to operate flights. On the other hand, the option to perform takeoffs of certain aircraft at all times of day may have a positive effect on the ability to operate these aircraft, taking better advantage of their operation.
(9) On February 2, 2011 the Company was provided with a copy of a motion to approve the filing of a claim as a derivative claim (“the Motion”) as well as a copy of the derivative claim. The motion was filed to the Economic Department of the Tel Aviv District Court by a holder of 5,000 Company shares (constituting 0.001% of its share capital). Note that the shareholder had submitted two demands to the Company, which had been rejected by the Company’s Board of Directors. According to the motion, the court was asked to approve a derivative claim to the amount of 22,800 thousand NIS against Israel (Izzy) Borowich, Tamar Moses Borowich, Amiaz Sagis, Nadav Palti, Amnon Lipkin-Shahak, Yigal Arnon, Eyal Rosner, Shimon Katzanelson and Yehoshua Ne’eman, who had served on the Company’s Board of Directors in 2005 during the ratification of the employment contract of the former Company CEO, Mr. Chaim Romano. The motion claimed, inter alia, that the aforementioned board members were negligent in determining and approving the yearly incentive bonus for Mr. Romano, who had served as Company CEO between 2005 and 2009, as well as regarding the Company’s reports on the formula of the bonus in question. The Company has yet to file is response. For details regarding the Securities Authority’s inspection report, see Note 42. 8.
d) Other proceedings:
Additional legal claims totaling $5.5 million exist against the Company, for which the Company has made provisions in its Financial Statements based on the advice of its legal counsel.
e) Income Tax – Withholding:
The Company has received agreed assessments for withholding tax through the 2005 tax year. As for the matters remaining in dispute, the Company received assessments for the years 1999 through 2005, amounting to approximately 162.3 million NIS ($43 million), including interest and linkage (not including fines). The Company disputed the Income Tax rulings regarding the three issues mentioned above and has appealed the assessments before the Tel Aviv-Jaffa District Court. The parties have begun holding talks in an attempt to reach an agreement regarding the assessments in question, and on February 10 2011 the Company’s Board of Directors ratified the signing of a settlement with the Income Tax Authorities (Ramla Assessment Clerk). Following the settlement, the Company received a discount assessment up to and including tax year 2010. See Note 28f.
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Note 28 - Taxes on Income
a. Deferred Tax Balances
The composition of deferred tax assets (liabilities) are detailed below:
Transferred Charged to from Other Other Comprehensive Balance as of Balance as of Charged to Comprehen- Income to Changes in December 31, January 1 2010 Gain/Loss sive Income Gain/Loss Tax Rates* 2010 Thousands of Dollars Timing differences Cash flow hedges 10,483 (200 ) (21,511) (542) 671 (11,099 ) Fixed assets (184,906 ) (16,510) - - 7,650 (193,766 ) Financial assets at fair value through profit or loss 5,103 570 - - (231 ) 5,442 Provisions, doubtful debt and employee benefit obligations 31,649 (3,234) - - 141 28,556 Frequent flyer plan 5,508 (5,156) - - 299 651
Total (132,163) (24,530) (21,511) (542) 8,530 (170,216)
Unused tax losses and benefits Losses for tax purposes 126,850 8,613 - - 1,961 137,424
Total (5,313) (15,917) (21,511) (542) 10,491 (32,792)
Transferred Charged to from Other Other Comprehensive Balance as of Balance as of Charged to Comprehen- Income to Changes in December 31 January 1 2009 Gain/Loss sive Income Gain/Loss Tax Rates* 2009 Timing differences Cash flow hedges 38,722 (808 ) (28,064) 633 - 10,483 Fixed assets (226,357 ) (4,772) - - 46,223 (184,906 ) Financial assets at fair value through profit or loss 11,144 (6,041 ) - - - 5,103 Provisions, doubtful debts and employee benefit obligations 41,599 (4,275) - - (5,675) 31,649 Frequent flyer plan 12,314 (6,727 ) - - (79) 5,508
Total (122,578) (22,623) (28,064) 633 40,469 (132,163)
Unused tax losses and benefits Losses for tax purposes 120,706 47,148 - - (41,004) 126,850
Total (1,872) 24,525 (28,064) 633 (535) (5,313)
* Changes to tax rates were recognized in the Statement of Operations
b. Timing Differences due to Investments in Investee Companies for which No Deferred Tax Liability was Recognized
The Group did not recognized deferred tax liabilities for subsidiaries and investee companies as the Group intends to hold and develop the investments, and the decision exists not to distribute taxable dividends in the foreseeable future. In addition, dividends from subsidiaries and associated companies are not taxable.
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c. Tax Expenses on Income (Tax Benefit) Charged to the Statement of Operations
2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Current tax expenses 399 171 Deferred taxes 5,968 (24,623) (7,972) Total tax expenses (tax benefits) 5,971 (24,524) (7,801)
d. The Effective Tax 2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Profit (loss) before taxes on income according to Statement of Operations 62,981(101,266 ) (50,251)
Statutory tax rate 25% 26% 27%
Tax expenses (revenues) according to statutory tax rate 15,745(26,329 ) (13,568)
Tax surcharge (savings) due to: Non-deductible expenses 717 1,270 4,876 Differences in calculation of taxable income due to exchange rate differentials Adjustments due to changes in tax rates (10,491) 535 891
Total taxes on income (tax benefit) presented in Statement of Operations 5,971 (24,524) (7,801)
e. Tax Laws Applicable to Group Companies
According to the Adjustments Law and the Income Tax Regulations (Rules Concerning the Maintenance of Accounting Records of Companies in Foreign Investments and of Certain Partnerships and the Determination of their Taxable Income), 1986 ("the Dollar Regulations"), the results of the Company and some of its subsidiaries for tax purposes are measured on the basis of adjustment to the exchange rate of the U.S. dollar.
The Company’s main subsidiaries operating in Israel are subject to the Income Tax Law (Inflationary Adjustments), 1985 ("the Adjustments Law"), which measures results in real terms on the basis of adjustment for changes in the CPI.
On February 26, 2008, the Knesset passed in the third reading the Income Tax Law (Inflationary Adjustments) (Amendment No. 20) (Limitation of Effective Period), 2008 ("the Amendment"), whereby the effective incidence of the Adjustments Law will end in the 2007 tax year, and as from the 2008 tax year, the provisions of the law will not apply, except for the transitional provisions, the purpose of which is to prevent distortions in the tax computations.
In accordance with the Amendment, starting tax year 2008, the adjustment of taxable income to a real basis of measurement shall no longer be calculated. In addition, depreciation of fixed assets and sums of losses transferred for tax purposes shall no longer be linked to the CPI, in such a manner that these sums will be adjusted to the CPI of the end of the 2007 tax year, and their link to the CPI shall be discontinued from that date onward.
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The Dollar Regulations will continue to apply to the Company even after the effective period of the Adjustments Law ends.
Some subsidiaries are assessed jointly with the Company.
The Company is deemed an industrial company under the Law for the Encouragement of Industry (Taxes), 1969 and, accordingly, is entitled to accelerated depreciation rates on aircraft and equipment as well as amortization of costs incurred in connection with the registration of shares for trading on a stock exchange.
Pursuant to the Income Tax Regulations - Depreciation, 1941, the Company is entitled to depreciate the cost of owned aircraft and spare engines at an annual rate of 30% and 40% of cost, respectively.
Overseas subsidiaries are subject to the tax codes in effect in their countries of residence.
Most of the countries in which the Company operates representative offices are signatories to treaties or mutual arrangements for the prevention of double taxation, which exempt the Company from income taxes on their operations in these countries.
In accordance with Amendment 147 to the Income Tax Ordinance, 2005, the 34% corporate tax rate shall be gradually reduced starting 2006 (for which a tax rate of 31% was established) until 2010, for which a tax rate of 25% was established (the tax rates in 2007, 2008 and 2009 are 29%, 27% and 26%, respectively).
On July 23 2009 the Economic Streamlining Law 2009 (Legislative Changes to Implement the 2009 and 2010 Economic Plan) (hereinafter - "the Arrangements Law") was published. According to the Arrangements Law, corporate tax rates will gradually decrease starting 2011, for which a tax rate of 24% was set, to tax year 2016, for which a corporate tax rate of 18% was set. The implementation of these amendments influenced the Company's deferred tax balances.
Amendment 174 to the Income Tax Ordinance - Temporary Order to Tax Years 2007, 2008 and 2009 (hereinafter: "The Amendment") was published on February 4 2010. In accordance with the Amendment, Israeli Accounting Standard 29 on the matter of adoption of IFRS, shall not apply to the determination of taxable income in the years in question even if applied for the purpose of preparing the financial statements. According to the Tax Authority’s January 18 2011 memo, the Tax Authority intends to recommend that the Minister of Finance act to extend the temporary order in question to tax year 2010.
f. Deduction Assessments
On February 10 2011 the Company’s Board of Directors ratified the signing of a settlement with the Income Tax Authorities (Ramla tax officer). This settlement came as a result of a dispute between the Company and Income Tax in which the Company received assessments followed by orders for 1998 through tax year 2005. Most of the assessments issued were estimated by the Company at a total sum of 186 million NIS ($52 million) including interest and linkage differentials up to December 31 2010. The key points of the dispute between the Company and the tax authorities are the value of flight tickets, on the basis of available seats and on the basis of reserved seats, granted employees as discounts, as follows: a. For flight tickets granted on an available seat basis, the Company’s position was that the value of the ticket shall be calculated at a rate of 22.5% of the flight ticket prices established as a basic price for the issue of employee economy class tickets, according to an arrangement conducted in the past with Income Tax and revoked in 1997. The assessor determined, in assessments issued for the Company for 1998-2005, the value of the flight ticket at variable rates from the average price of economy class tickets, which are higher than the rate set by the Company above (up to 75% of the price of an average ticket), this based on the average load factor for the month in which the flight took place. b. For flight tickets on the basis of a reserved seat the Company allows its employees to purchase in return for a payment of 50% of the cost of a flight ticket set by the Company at an average economy class price, the Company paid fixed tax levels, but in assessments issued for the Company for 2001 - C 73 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
to 2005, Income Tax determined that the value of the flight ticket is 214% of the price of an average economy class ticket. c. In addition, the assessments issued for 1998 through 2002 included tax debits for employees stationed abroad for periods of over 4 years as well as for a tax offset paid by Company employees in the U.S. The Company has appealed these assessments before the District Court based, among other things, on economic opinions materially different from those of the Income Tax assessments. The parties held talks to resolve the disputes in question and on February 10 2011 the Company’s Board of Directors ratified a settlement between the Company and the Ramla tax officer, as follows: a. The Company shall pay Income Tax up to and including 2010 a final and absolute sum of 65 million NIS ($18 million as of the reporting date) including payment for the assessments for which the orders were issued for tax years 1998-2005 and the full deduction debts for employee flight tickets and other surplus expenses for 2006-2010. b. An agreement regarding the value of flight tickets for Company employees in the purchase of flight tickets on the basis of an available seat and on the basis of a reserved seat, for 2011 through 2013. On February 16 2011 the agreement was confirmed by the court, thus concluding the legal proceedings between the Company and Income Tax regarding the deduction assessments issued for the Company. For all of the above Income Tax requests, up to and including 2010, the Company made financial provisions exceeding the sum of the settlement described above and therefore the Company reduced the sum of the provision listed in its books and recognized other revenues to the amount of $22.25 million in its 2010 Financial Statements under “other revenues”. In addition to the above, as of December 31 2010 an appropriate provision exists in the Company's books for Social Security commitments deriving from the settlement with Income Tax.
g. Final Tax Assessments
The Company has received final tax assessments up to and including 2002. In addition, the Company has received tax assessments considered final up to and including tax year 2006. Chief subsidiaries have received tax assessments considered final for up to and including tax year 2006.
Note 29 - Pending Liabilities, Guarantees and Commitments
a. Pending Liabilities
In the matter of lawsuits see Note 27c above.
b. Safety Rating Decrease
On December 19 2008 the U.S. Federal Aviation Agency (FAA) announced that it would be lowering the flight safety rating of the State of Israel to Category 2. This announcement refers to the level of civil aviation safety supervision in the State of Israel on behalf of Israeli aviation authorities, including the Civil Aviation Authority at the Ministry of Transportation. Although the FAA announcement was not issued against the Israeli airlines and the inspection or safety rating do not derive from the abilities or safety status of Israeli airlines, the implication of the announcement is the placing of active limitation on airlines flying from Israel to the U.S., including the Company, pertaining to, inter alia, restrictions on increased activity, examining Israeli airlines in the U.S. as well as restrictions on code sharing agreements with U.S. airlines. The effects of the rating decrease may harm the Company, including by freezing bilateral agreements and the inability to alter existing agreements; freezing commercial agreements without the possibility of submitting requests for added frequencies, adding flight times, changing destinations or receiving new flight destinations; freezing airlines' operational operator's licenses and the inability to add or integrate new aircraft on these routes; damaging code sharing agreements; careful examination of planes arriving at the U.S. from Israel, which may lead to significant delays in planned flight schedules. Note that in March 2009 the Company addressed a letter to the Minister of Transportation and Road Safety in which it noted that the State was responsible for the decreased flight safety rating and the damages caused the Company as a result.
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The State of Israel’s safety rating remained unchanged in 2010 and it has yet to be raised back to Category 1 by the FAA and the Company has no knowledge regarding the date the restoration of Category 1 will occur. c. Guarantees:
Composition of guarantees provided by the Group to third parties: As of December 31 As of December 31 2010 2009 Thousands of Thousands of Dollars Dollars
To secure employee retirement programs 4,949 4,653 To secure employee loans 207 221 To secure subsidiaries’ liabilities - 100 To aviation authorities, customs authorities and other 4,830 7,920 third parties 9,986 12,894
d. Commitments
1. Leasing and rental fees:
a. The Company leases planes under operating leases, generally in return for monthly leasing fees plus a payment for maintenance reserves based on actual flight hours. Most of the agreements include options for extending and shortening the leasing contracts.
b. For details on of the minimum lease fees for the fixed components (but excluding the payment for the maintenance reserves) payable for the lease of aircraft and payments to the IAA, see Note 26.(3).
c. The Company has lease commitments for land and buildings in Israel and abroad, including in various airports, as well as offices used by its branches.
2. Commitments with the Israel Airports Authority (IAA):
a. The Company has a usage right (permit) to 290 hectares of land at BGN until December 31 2010, with an option to renew it for an additional 25-year period. The Company is currently negotiating with the IAA regarding the extension of the agreement.
Prior to privatization, on May 19, 2003, the Company and the IAA, with the approval of the Ministerial Committee for Social and Economic Affairs, reached an understanding concerning new permit fees for which the Company will be obligated to the IAA.
Under this agreement, the annual payment for the areas referred to above will be $960 thousand in 2005, rising by 7.4% per annum up to a maximum of $4 million per annum.
b. On October 19, 2004, an amendment was added to this agreement, according to which in addition to the payment for the land, the Company shall pay the IAA annual usage fees for certain fully depreciated buildings and installations.
c. The Company has a usage fee agreement (permit) with the IAA for a passenger service warehouse in BGN encompassing 4,380 square meters. The annual usage fees are $480 thousand. The agreement shall be in effect until December 31, 2012.
d. The Company has usage rights to areas in BGN airport for its cargo shipping activity, which include the Maman Building compound, amounting to 275 sq. meters in size, in return for yearly usage fees of $140 thousand. This agreement was extended to March 31
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2014 and starting April 2011 and additional space of 170 square meters was added in return for additional yearly usage fees to the amount of $80 thousand. These agreements include an option to extend to December 31 2015.
e. The Company is obliged to pay flight fees, airport taxes and permit fees to the IAA. The Company enjoys the maximum reduced rate due to the volume of its activity at BGN.
f. In November 2004, within the framework of Ben Gurion 2000 project, the IAA opened Terminal 3. In light of the transfer of some of the Company's activity to Terminal 3, an agreement was signed in December 2006 between the Company and the Airport Authority regarding the use of the Terminal 3 passengers' lounge.
The agreement shall remain in effect until November 2011, for total consideration $2.8 million a year. Additionally, agreements were signed to grant permission for other areas in Terminal 3 until November 2014, in return for rental fees of $2.3 million a year.
In April 2000, the Company signed a new agreement-in-principle for leasing an area of 20 hectares in order to set up a maintenance center, a hangar and supporting facilities within the framework of Ben Gurion 2000 project. The IAA council ratified the transaction, but the agreement is subject to the signing of a detailed agreement between the parties as well as the ratification by the Company’s Board of Directors. As of these statements, no detailed agreement has yet been signed between the parties.
3. Commitments for Maintenance of Engines and Aircraft:
The Company has several agreements with various entities for maintenance services to engines and planes. The agreements are long-term. Some of the agreements are based on time & materials while others are based on cost per hour flown.
Regarding engine maintenance agreements, see Note 16l.
4. Code Sharing Agreements with Foreign Airlines:
In March 2010 a code sharing agreement signed with Air China in June 2009 came into effect. In a later stage the Company intends to add its code to internal Air China flights from Beijing to other Chinese destinations, both ways, and possibly on international Air China flights (subject to regulatory approval from third nations).
Regarding the code sharing agreement signed December 2009 with Turkish airline Atlas Jet, which was expected to come into effect in June 2010, the Company and Atlas Jet decided via mutual consent and in light of the situation following the flotilla events to freeze activity on the line to Istanbul until further notice.
In November 2010 the Company signed a code sharing agreement with Russian airline Siberia Airlines (hereinafter: “S7”) on the Tel Aviv-Novosibirsk route. The purpose of the agreement is to expand the Company’s Russian destinations and open the door to expanding cooperation to additional Russian destinations. The agreement is based on a two-way free sale format and shall apply to the Company’s flights to Moscow and to S7 flights to Novosibirsk connecting to these flights, both ways. The sale shall be made directly from the seat inventory of each of the companies, while defining the appropriate listing classes and price levels for each class and each flight segment. The agreement was approved by the Minister of Transportation and Road Safety and the Restraint of Business Commissioner, as required, and came into effect and has been applied starting late December 2010.
In November 2010 the Company signed a code sharing agreement with Bulgaria Air on the Tel Aviv-Sofia route. The chief purpose of the agreement is to provide the Company's customers with an improved product and the agreement shall apply to all the flights each party operates on the route, in a block space format, and accordingly, each party will offer the other part of the aircraft’s load for sale in flights operated by them. Note that a code sharing agreement had existed between the parties for the route up to 2009, before it was cancelled in light of the absence of approval from - C 76 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
the Restraint of Business Supervisor. The current agreement requires the approval of the Restraint of Trade Commissioner and the Minister of Transportation and Road Safety as well as approvals by relevant Bulgarian authorities, as a precondition for its activation.
In December 2010 a code sharing agreement was signed with Armenian airline Armavia Air (hereinafter “Armavia”) on the Tel Aviv-Yerevan route. The agreement is based on a soft block format, and according to it Armavia shall provide the Company with seats for sale on both of Armavia’s weekly flights on the route. The agreement was approved by the Armenian aviation authorities and by the Israeli Minister of Transportation and Road Safety and the Restraint of Trade Commissioner and is expected to come into effect starting late March 2011.
In December 2010 the Company signed a code sharing agreement with Ukrainian airline Aerosvit, for the Tel Aviv-Kiev route. The agreement is according to a two-way free sale format and shall apply to wither party’s flights in accordance with the terms of the agreement. The sale shall be made directly from the seat inventory of each of the companies, while defining the appropriate listing classes and price levels for each class and each flight segment. Note that a code sharing agreement had existed between the parties in the past, in a block space format. This agreement was cancelled in 2009 due to the lack of an approval from the Restraint of Trade Commissioner. The current agreement requires the approval of the Restraint of Trade Commissioner and the Minister of Transportation and Road Safety as well as approvals by relevant Ukrainian authorities, as a precondition for its activation.
The Company signed a cooperation agreement (on an interline basis) with American airline Jet Blue Airlines, which operates a large volume of domestic U.S. flights departing from JFK Airport in New York. The agreement came into effect in November 2010, allowing the Company to offer a variety of new continuing destinations throughout the U.S, Latin America and the Caribbean.
Note 30 - Shareholders' Equity
a. General
Following the publication of a prospectus in May 2003 (and amendments to the prospectus dated June 3 and 4, 2003) (hereafter: “the Prospectus”) for the issuance of shares and options to the public, together with a tender offer made by the Government of Israel, the Company’s securities were registered for trade on the Tel Aviv Stock Exchange in June 2003. According to the Prospectus, the Company issued 49,000,000 registered ordinary shares (OS) worth 1 NIS NV with total par value of 49,000 thousand NIS, together with 396,000,000 options and buy options registered to bearer.
b. The Company's Share Capital as of December 31, 2010:
Registered Issued and Paid-Up
Special Ordinary Special Ordinary Shares Shares Shares Shares 1 NIS NV 1 NIS NV 1 NIS NV 1 NIS NV NIS NIS NIS NIS
Balance – December 31 2008 1 550,000,000 1 495,719,135
Balance as of December 31 2009 1 550,000,000 1 495,719,135
Balance as of December 31, 2010 1 550,000,000 1 495,719,135
c. In the period from January 1 2007 through June 5, 2007, the public exercised 94,930,801 options (Series 1) for the same number of ordinary shares worth 1 NIS NV each, issued by the Company, in return for $31,820 thousand.
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These proceeds were deposited in the severance pay fund of entitled employees, except for 30.4 million NIS (including interest accrued as of the report date) not yet deposited, as in Note 23.c.3.b
d. On March 23, 2006, the General Meeting of the Company approved the increase of the Company’s authorized share capital by 54,279,453 NIS, bringing the total to 550,000,001 NIS after said increase, divided into the State’s special share worth 1 NIS NV and 550,000,000 ordinary shares registered to bearer worth 1 NIS NV each.
e. The Rights Associated with the Special State Share:
On May 18, 2003 the Company allotted the State of Israel a special, non-sellable, non-transferable share. This share was designed to protect the State’s vital interests, in accordance with the following Government resolutions:
1. Maintaining the Company as an Israeli company, subject to Israeli law; 2. Keeping the operating capability and the flight capability of carrying passengers, and cargo, above a minimum established level; 3. Preventing any hostile interests from taking over the Company; 4. Maintaining security and safety arrangements as determined by state bodies on behalf of the State.
In addition, on October 12, 2004, the Knesset’s Finance Committee approved the issuance of an order under the Government Corporations Act requiring the Company to employ, at all times, Israeli crew members, and – in Israel – Israeli ground personnel, in a number not lower than that required for continuous and simultaneous operations in an emergency of all the aircraft fleets constituting the minimal flight capacity which the Company is required to maintain as stipulated by directives of the Special State’s Share. As of the approval date of the financial statements, the provisions of this order did not require that the Company make any changes in its method of operations or in the composition of employees.
f. Dividend Distribution Policy
On November 20, 2007, the Company's Board of Directors resolved to update its dividend distribution policy. Pursuant to this policy, the Company will distribute dividends from time to time, at the discretion of the Board of Directors and subject to the Company's needs. Implementation of this policy is subject to any relevant law provisions as well as the assessment of the Company's Board of Directors of the Company’s ability to meet its present as well as forecasted liabilities and taking into account its liquidity, and present as well as future business plans and activities. The adoption of this policy does not diminish the authority of the Board of Directors of the Company to decide upon a change, amendment and/or abolition of the currently established dividend policy and/or to approve any additional distributions that comply with the law and/or to decide on a reduction of actual distributions or to preclude them altogether should it be warranted by changes from time to time in the Company’s liquidity, operations and conditions.
g. Senior Employee Option Plan:
1. On February 26, 2006, the Company’s Board of Directors resolved to adopt an option plan for employees and executives of the Company (hereafter: the 2006 options plan). On that date, the Board of Directors confirmed that the number of options that would serve as a pool for allotment under the Plan would stand at 17,092,129 options, exercisable for 17,092,129 ordinary Company shares of worth 1 NIS NV each, subject to adjustments. The Board of Directors is permitted, from time to time, to add to this quantity of options. At the same time, the Company's Board of Directors approved an allotment of 17,092,129 options to approximately 50 offerees, of which approximately 10 were senior executives of the Company and approximately 40 other Company executives. The allotment of the options to the Company's executives was also ratified by the Audit Committee of the Company on February 26, 2006. The allotment of the options was conditional upon the approval of the General Meeting of the Company for the increase in the Company's registered capital. Such approval was obtained on March 23, 2006 and the allotment was executed on the same date.
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The options will vest and become exercisable in equal parts over a 4-year period, beginning from January 1, 2007 (one quarter of the options will vest each year), conditional upon the offeree being employed by the Company, or rendering services to the Company, on the vesting date. All options granted but not exercised will expire and be cancelled at the end of 3 years from the date that each option became vested.
The theoretical exercise price of one option into one share will be 2.9733 NIS. The exercise price is the theoretical price not paid by the employee. In the event that the option is exercised, the employee will be entitled to shares in a number equivalent to the difference between the price of the underlying share (the closing price on the Tel-Aviv Stock Exchange of one ordinary share of the Company at the end of the trading day on which the Company received the instruction to exercise) and the theoretical exercise price, multiplied by the number of options in his possession, divided by the price of the underlying shares. The theoretical exercise price is subject to customary adjustments in the event of dividend distributions and changes in composition of the Company's capital. The share price for the purpose of the computation is the Company's share price at the close of trading on March 23, 2006 (3.837 NIS). The exercise price is 85% of the share price on February 26, 2006 –2.973 NIS.
2. On May 23, 2006, the Board of Directors of the Company resolved to increase the quantity of options in the options pool for allotment pursuant to the options plan for compensating Company executives and other employees by another 3,000,000 options. Such options will not be marketable and they will be exercisable into up to 3,000,000 ordinary shares of the Company worth 1 NIS NV each. The Board of Directors appointed the Human Resources and Appointments Committee to manage the options program and authorized the Committee to allot these options to Company executives, in accordance with the criteria stipulated by the Board of Directors. The theoretical exercise price of each option (as explained in Par. 1 above) will be 85% of the average closing price on the Tel-Aviv Stock Exchange of one ordinary share of the Company during the 30 trading days that preceded the decision of the manager of the program to make an allotment to each offeree, except for an offeree who served in the position of vice-president or division head in the Company on March 23, 2006, and who had not received options according to the allotment decision made during March 2006, and to whom the theoretical exercise price was set at 2.9733 NIS. After the Human Resources and Appointments Committee decided on December 27, 2006 to allocate options, 3,072,536 options were allotted on December 31, 2006 to 9 senior employees. The options were divided into four equal installments which will vest over 3.5 years as follows: one quarter will vest on June 30 of each one of the years 2007 through 2010. The theoretical exercise price of one option into one share will be 1.8894 NIS, subject to the adjustments made for dividend distributions and changes in the composition of the Company's capital. The share price for the purpose of the computation is the price of the Company's share at the close of trading on December 31, 2006 (2.08 NIS). The exercise price is 85% of the average price during the 30 trading days that preceded the Board of Directors' resolution of December 27, 2006, that being 1.89 NIS. All options granted but not exercised will expire and be nullified 3 years from the date each option vested.
3. On November 20 2007, the Company’s Board of Directors resolved to publish an additional outline for the purpose of allotting options located in the options pool available for allotment, in accordance with the option plan for compensation of Company executives and other employees, as discussed in g.1 and g.2 above, the balance of which as of that date is 3,382,843 options. The options will be exercisable for up to 3,382,843 ordinary Company shares worth 1 NIS NV each. The Board of Directors approved the appointment of a Human Resources and Appointments Committee to continue serving as the administrator of the option plan, and empowered the committee to allot the above options to the Company’s managers, in accordance with the criteria provided by the Board of Directors. The theoretical exercise price of each option (as explained in Par. 1) will be 85% of the average closing price of an ordinary share of the Company on the Tel Aviv Stock Exchange during the 30 trading days that preceded the decision of the plan administrator for an allotment to each offeree, that being 2.01 NIS. - C 79 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
The options will be distributed in four equal installments that will vest as follows: one-quarter will vest on July 1 of each of the years from 2008 up to and including 2011. All options granted but not exercised will expire and be nullified 3 years from the date each option vested. Pursuant to this, on December 26, 2007, 2,195,852 options were allotted to six additional executives.
4. None of the options in the three plans will be registered for trade on the stock exchange, although the shares derived from the exercise of options will be registered for trade on the stock exchange. The options will be allocated to a trustee in accordance with Section 102 of the Income Tax Ordinance.
5. According to the provisions of Accounting Standard No. 2 (Stock-Based Payment), the Company records expenses pertaining to the options grant based on their economic value. The computation is made on the date of the grant, for each batch separately, based on the Black & Scholes model. The expense will be recorded over the vesting period of each batch, with the extent of the expense being a function of the quantity of options granted and the economic value of each option.
The option’s value will be computed based on the plan’s terms and subject to the following assumptions:
. The expected lifespan for the exercise of each installment has been computed as the average of the vesting period of each installment and the expiration date. . The standard deviation has been computed based on the daily yield of the price of the share on the stock exchange during a period equaling the expected period for exercise of each batch (as outlined above). The maximum standard deviation taken from the date of issuance of the Company for trading (while neutralizing the first trading day) for batches whose expected period for exercise is longer than the period during which the Company’s shares are traded on the stock exchange. . Discount rate–the rate of yield of unlinked debentures (“Shahar”) which conforms to the expected period of exercise of each batch. . The computation of the value of the benefit did not take into account the retirement of employees before the conclusion of the vesting period.
The following is a summary of the parameters used in the model:
Plan A Plan B Plan C Share price in NIS 3.84 2.08 2.34 Exercise price in NIS 2.97 1.89 2.01 Expected fluctuation (in %) 27.95-36.65 32.94-36.84 32.57-42.77 Lifespan of options (in years) 2.11-5.11 2-5 2-5 Risk-free interest rate (in %) 4.80-6.45 4.96-5.35 4.58-5.18 Average option value according to B&S (in NIS) 1.75 0.75 0.90
Expense listed in 2008 in thousands of NIS 3,005 638 1,065 Expense listed in 2009 in thousands of NIS 1,071 27 156 Expense listed in 2010 in thousands of NIS - 51 146 Expense listed in 2008 in thousands of dollars 838 179 299 Expense listed in 2009 in thousands of dollars 275 6 40 Expense listed in 2010 in thousands of dollars - 14 39
Expense projected in 2011 in thousands of NIS - - 47
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Number of Options Plan A Plan B Plan C
Outstanding as of January 1, 2008 13,636,750 3,072,536 2,195,852 Waived (1,959,605) - - Outstanding as of December 31 2008 11,677,145 3,072,536 2,195,852
Exercisable as of December 31, 2008 5,838,573 1,536,268 548,963
Outstanding as of January 1 2009 11,677,145 3,072,536 2,195,852 Waived (301,651) (906,538) (492,394) Outstanding as of December 31, 2009 11,375,494 2,165,998 1,703,458
Exercisable as of December 31, 2009 8,531,621 1,624,499 851,729
Outstanding as of January 1 2010 11,375,494 2,165,998 1,703,458 Waived (4,722,065) (1,005,172) (581,920) Outstanding as of December 31 2010 6,653,429 1,160,826 1,121,538
Exercisable as of December 31 2010 6,653,429 1,160,826 841,154
6. Service Agreement and Option Allocation to the Chairman of the Company's Board of Directors
On April 30 2009, the Company Audit Committee and the Board of Directors decided to approve the Company's agreement with the Chairman of the Company's Board of Directors - Mr. Amikam Cohen (hereinafter – "the Chairman of the Board”) to provide Chairman services retroactively starting February 1 2009 (hereinafter – "the Service Agreement"), the key points of which are described in Note 38d below.
The Company Audit Committee and the Board of Directors decided to approve the issue of non-tradable options to the Chairman of the Company’s Board of Directors (hereinafter – “the Options Plan”). The options shall be granted within the framework of the agreement to provide services as Chairman of the Company's Board of Directors. On June 24 2009 the General Meeting ratified the Service Agreement and option issue to the Chairman of the Company's Board of Directors.
The Company shall grant the Chairman of the Board 4,650,000 non-tradable options exercisable as 4,650,000 ordinary Company shares worth 1 NIS NV each (hereinafter – “the Exercise Shares”) The options shall be allocated free of charge. Assuming the exercise of all the options, the Exercise Shares shall constitute 0.95% of the Company's paid-up capital (including fully diluted). The Company has the option of stating that exercise of the options shall take place in return for Company shares of an amount reflecting the sum of the financial benefit embodied in the options alone (cashless exercise) and in the event that the Company chooses this option, the amount of shares actually issued shall be smaller than the rate denoted above.
The options may be exercised as Company shares, subject to adjustments and as detailed below:
Vesting – The right to exercise the option shall vest in three portions which shall vest throughout the Chairman of the Board's service at the Company, as follows: a. 12 months from the beginning of the Chairman's service, that being February 1 2009 (hereinafter – "the Allocation Date"), the Chairman of the Board shall acquire vesting for the exercise of 1/3 of the options. b. 2 years from the allocation date, the Chairman shall acquire vesting for an additional 1/3 of the options. c. 3 years from the allocation date, the Chairman shall acquire vesting for an additional 1/3 of the options.
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d. Starting from the end of the first year from the allocation date, in the event of the discontinuation of the Chairman's service prior to the passing of two or three years, the Chairman of the Board shall be entitled to a relative portion of the options as stated in paragraphs b. and c. above, in such a manner that every three months after the end of the first year since the allocation date, the Chairman of the Board shall be entitled to exercise an additional 387,500 options.
Exercise Price – The exercise price of each option shall be 0.885 NIS, the closing price of a Company share on February 1 2009, which is when the Chairman of the Board began his tenure, subject to adjustments established in the Option Plan.
Exercise Period – The Chairman of the Board shall be entitled to exercise any option portion vesting as Company shares, starting from the vesting date of each portion until 26 months from the vesting date of each portion (hereinafter as regards vested options – "the Exercise Period"), except if the options or any portion thereof expired prior to the exercise period, all in accordance with the Options Plan. All options granted to the Chairman of the Board and not exercised by him into Company shares by the end of the exercise period shall expire and may not be exercised.
Assessing the Fair Value of the Options
The fair value of the above options is assessed using the application of the Black & Scholes model (as well as reference to Binomial options pricing model for comparison). Within this framework, the Company did not take the influence of the vesting conditions into account. The value of the options, based on the following parameters, for the date on which the option plan was approved by the Company's General Meeting was 1,310 thousand NIS ($332 thousand on that date).
The parameters used in the application of the model, as of June 24 2009, are as follows:
Share price (in NIS) 0.879 Exercise price (in NIS) 0.885 Expected fluctuation (*) 45% - 42% Option lifespan (in years) (**) 3.7 - 2.4 Risk-free interest rate 3.3% - 2.3% Expected dividend rate 0%
Thousands of NIS Thousands of Dollars
Expense listed in 2009 782 200 Expense listed in 2010 397 106
Expense projected for 2011 129 Expense projected for 2012 3
(*) The expected fluctuation is determined based on historic fluctuations in the price of the Company's share.
(**) The lifespan of the options is determined in accordance with the assumption that their exercise is expected to take place in the average period between the vesting period and the end of the options' lifespan.
7. Option Allocation to the Company CEO:
On October 21 2009, the Company's Board of Directors decided to appoint Mr. Elyezer Shkedi as the Company's new CEO (hereinafter – "the CEO"). On January 6 2010 the Company's Audit Committee and Board of Directors ratified the CEO's terms of employment, detailed in Note 38f.
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The Company Audit Committee and the Board of Directors decided to approve the issue of non-tradable options to the CEO, as part of the terms of his employment. The Company shall grant the CEO 9,914,382 options exercisable as 9,914,382 ordinary Company shares worth 1.00 NIS NV each which constitute, as of the signing of the agreement, 2% of the Company's paid-up capital and 1.90% fully diluted. The options have been granted in accordance with the Company's 2006 option plan and in accordance with the option agreement with the CEO. Note that the CEO or the Company has the option of stating that exercise of the options will take place in return for Company shares of an amount reflecting the sum of the financial benefit embodied in the options alone (cashless exercise) and in such a case, the amount of shares actually issued shall be smaller than the rate denoted above.
The options may be exercised as Company shares, subject to adjustments and as detailed below:
Vesting – The right to exercise the option shall vest in three equal yearly portions (one third each year) throughout the CEO's first three work years, starting November 1 2009. In the event of the discontinuation of the CEO's employment after the end of the first work year the options shall vest on a quarterly basis. In the event of the discontinuation of the CEO's employment within six months after a change of control, all options allocated to the CEO the vesting date of which has yet to be reached shall vest immediately, and they shall be exercisable within 12 months from the date on which the CEO stopped working in practice.
Exercise Price – The exercise price of each option shall be 0.965 NIS, the closing price of a Company share on November 1 2009, which is when the CEO began his term in office.
Exercise Period – Any portion of options vested may be exercised up to 60 months from the vesting date of that portion, or at the end of twelve months from the actual end of the CEO's employment
Adjustments – the amount of options and/or the exercise price, as the case may be, shall be subject to adjustments as detailed in the agreement with the CEO, including adjustments due to dividends and due to merger/sales agreements.
Assessing the Fair Value of the Options
The fair value of the above options is assessed using the application of the Black & Scholes model (as well as reference to Binomial options pricing model for comparison). The value of the options, based on the following parameters, for the date on which the option plan was approved by the Board of Directors, January 6, 2010 is 3,847 thousand NIS (some $1,029 thousand on that date).
The parameters used in the application of the model, as of June 24 2009, are as follows:
Share price (in NIS) 0.968 Exercise price (in NIS) 0.965 Expected fluctuation (*) 43% - 40% Option lifespan (in years) (**) 5.3 - 3.9 Risk-free interest rate 4.1% - 3.6% Expected dividend rate 0%
Thousands of Thousands of NIS Dollars
Expense listed in 2009 424 113 Expense listed in 2010 2,344 626
Expense projected for 2011 854 Expense projected for 2012 225
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(*) The expected fluctuation is determined based on historic fluctuations in the price of the Company's share.
(**) The lifespan of the options is determined in accordance with the assumption that their exercise is expected to take place in the average period between the vesting period and the end of the options' lifespan.
Note 31 - Financial Instruments
a. Capital Management Policy
The Group manages its capital in order to ensure that the Group's entities may continue to exist as "going concern" while increasing the yield of its shareholders, by preserving an optimal ratio of debt to capital.
The capital structure of the Company consist of debt, which includes the loans detailed in Note 22, cash and cash equivalents and shareholders' equity which includes issued capital, capital reserves and retained earnings as detailed in the Report of Changes in Shareholders' Equity.
b. Principal Accounting Policies
Details regarding principal accounting policies and methods adopted, including recognition conditions, the basis of measurement and the basis according to which revenues and expenses were recognized relative to each group of financial assets, financial liabilities and capital instruments are presented in Note 2.
c. Financial Risk Management Goals
The Company has a Market Risk Management Committee headed by Mr. Nadav Palti, which is responsible for determining the policies to cover existing exposures. The CFO is responsible for the execution of the policies and for reporting to the Market Risk Management Committee.
The Company's financial division provides services to its business activity, provides access to local and international financial markets, supervises and manages the financial risks involved in the Company's activities by way of internal reports that analyze levels of exposure to risk according to degree and strength. These risks include market risks (including currency risk, interest rate risk and jet fuel price risk) credit risk and liquidity risk.
The Company reduces the influence of these risks by the use of derivative financial instruments in order to hedge its exposure to risk. Use of the derivative financial instruments is in accordance with Group policy approved by its Board of Directors, which sets written principles regarding currency risk management, interest rate risk, jet fuel price risk, credit risk, the use of derivative financial instruments and non-derivative financial instruments and the investment of surplus liquidity. Compliance with policy and with permitted exposure levels is supervised by the Risk Management Committee on a continuous basis. The Market Risk Management Committee instructs Company Management from time to time to deviate from said policy for limited amounts of time, in accordance with market developments.
d. Market Risk
The Group's activity primarily exposes it to financial risks of changes in the exchange rates of foreign currency (see Section e. below), changes in interest rates (see Section f. below) and price risk due to jet fuel prices (see Section g. below). The Group holds a variety of derivative financial instruments in order to hedge its exposures to market risks, which include:
Forward agreements for swapping foreign currency for the reduction of the Company's exposure from salary and local supplier payments in NIS. IRS swap agreements to reduce the risk deriving from increases in interest rates.
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Swap agreements ands options for projected purchases of jet fuel for the reduction of exposure to changes in jet fuel prices.
Over the course of the reported period, no change occurred in market risk exposure factors or in the way the Group manages or measures risk.
e. Currency risk
Most of the Company's revenues and expenses are in foreign currency (mainly the USD), other than a number of expenses in NIS, primarily most salary expenses paid in Israel in NIS. Accordingly, a change in the dollar/shekel rate affects the Company's NIS expenses. In addition, in the case of a devaluation of the euro in relation to the dollar, the excess of payments over receipts in euro reduces the Company's revenues. The Company also has balance sheet exposure to a devaluation of the dollar vis-à-vis the NIS due to the excess of financial liabilities over financial assets denominated in a currency other than the dollar (mostly, the NIS).
The carrying amounts of the Group's financial assets and liabilities denominated in foreign currency are:
Assets Liabilities As of December 31 As of December 31 2010 2009 2010 2009 Thousands of Dollars
Euro or linked 20,060 18,541 28,749 27,050 NIS 56,019 29,706 39,692 26,918
Foreign Currency Sensitivity Analysis
The Group is exposed primarily to the euro and NIS. The following table details the sensitivity to a 10% increase or decrease in the appropriate exchange rate. 10% is the sensitivity rate used in reports to key administrative personnel, and this index represents Management's estimates regarding the likely possible changes in exchange rates. The sensitivity analysis includes existing balances of financial items denominated in foreign currency and adapts their translation at the end of the period to a 10% change in foreign currency rates.
A positive number in the table represents an increase in earnings or in loss and an increase in equity when the dollar grows 10% stronger in comparison to the currency in question, or a decrease in earnings or loss and a decrease in equity when the dollar is weakened by 10% compared to the currency in question.
The influence of a 10% increase in the dollar versus the other currencies, before tax influence:
NIS Influence Euro Influence As of December 31 As of December 31 2010 2009 2010 2009 Thousands of Dollars
Profit or (loss) (1,484) (254) 790 773
Forward Agreements for Foreign Currency Swaps
From time to time, the Company examines the need to invest in derivative financial instruments to reduce its exposure to currency risks. It is the Company's policy for the dollar/shekel exchange rate to hedge half of the Company's shekel expenses for a period of up to one year forward. When it holds a derivative financial instrument, the Company is exposed to changes in the fair value of these financial instruments resulting from changes in their market value.
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In order to reduce exposure to the USD/NIS exchange rate, in 2009-2010 the Company conducted several transactions the purpose of which was to hedge part of the Company’s expected NIS payroll payments for a period of up to one year from the end of the reported period. These transactions are recognized as cash flow hedges for accounting purposes. The fair value of the forward agreements for foreign currency swaps as of the balance sheet date was established using published future exchange rates and yield curves deriving from published interest rates matching the repayment dates of the contracts denominated in foreign currency.
Over the course of 2010 the Company conducted an in-depth examination of its foreign currency hedging policy; following this examination, in December 2010 the Company Board of Directors decide to change its financial risk hedging policy, in accordance with the recommendations of the Market Risk Management Committee and Company management. According to the Company’s revised policy, the Company shall hedge is expected cash flow exposure at a rate of 75% for the coming 12 months on a monthly basis. The extant of the hedging shall be determined by management.
Cash Flow Hedging
The following table details the base sums of the transactions and the remaining terms of forward agreements for foreign currency swaps, as they exist as of the balance sheet date:
Average Exchange Sums of Rate Transactions Fair Value USD – NIS Thousands of Dollars Cash Flow Hedging
Up to 11 months 3.82-3.84 165,000 12,170
Regarding the Group's accounting policy regarding cash flow hedging, see Note 2o.
Over the course of the year, equity increased by a sum of $5,647 thousand after tax, due to the effectiveness of cash flow hedging as a defense against cash flow risk due to exchange rates.
Subsequent to the balance sheet date, in February 2011, the Company entered into additional financial transactions intended to protect the Company from drops in the exchange rate of the USD vs. the NIS for a period of 13 months ending February 2012. These transactions are recognized as cash flow hedges for accounting purposes.
Sensitivity Analysis of Forward Agreements for Foreign Currency Swaps
The sensitivity analysis is determined on the basis of exposure to foreign currency exchange rates of derivative and non-derivative financial instruments as of the balance sheet date. The sensitivity analysis was prepared under the assumption that the sum of assets as of the balance sheet date remained unchanged throughout the entire reporting period. For the purpose of reporting on foreign currency rate risk internally for key management personnel, an increase or decrease rate of 10% was used, representing Management's policy regarding reasonable change in foreign currency exchange rates.
Assuming that the NIS-USD exchange rates increased/decreased by 10% with all other parameters remaining unchanged, the influence on pre-tax equity would be as follows:
Equity as of December 31 2010 would increase/decrease respectively by $16.6 million (as of December 31 2009 it would increase/decrease respectively by $15 million).
f. Interest Risk
The Group is exposed to interest risk as the Company has taken loans at variable interest rates. The risk is managed by the Group by maintaining an appropriate ratio between variable interest and fixed interest - C 86 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
loans, by making use of interest rate swap contracts. The hedging actions are evaluated regularly in order to adapt them to projections regarding the desired interest rate and hedged risk. An optimal hedging strategy is guaranteed by adapting the Group's loan mixture and conducting back to back hedging against the payoff tables of existing loans.
Over the course of 2010 the Company conducted an in-depth review of its interest hedging policy. As a result of this review, in late December 2010 the Company Board of Directors decided to continue with its existing interest hedging policy, in which the Company hedges its cash flow exposure to the LIBOR interest rate (exposure deriving from Company loans), at a scope of up to 50% of total exposure for a horizon of up to 5 years. Interest rate hedging shall be carried out using financial instruments (such as IRS) or by taking some of the loans at fixed interest.
The Group's exposure to interest rates for financial assets and liabilities is described in the section on liquidity risk management in this Note below.
Over the course of the reported year no material change occurred in interest risk exposure factors or in the way the Group manages or measures risk.
Interest Rate Swaps
Within the framework of interest rate swap agreements, the Group entered into contracts to replace differences between fixed and variable interest rate sums calculated for agreed-upon listed principal sums. These contracts allow the Group to reduce the risk from variable interest rates to the fair value of an issued debt at fixed interest and exposure of the cash flow of a debt issued at variable interest. The fair value of the interest rate swaps as of the balance sheet date is established by capitalizing future cash flows using curves as of the balance sheet date and the credit risk inherent in the contract as stated below. The average interest rate is based on the balances existing at the end of the year.
Cash Flow Hedging
The following tables detail the fixed contractual interest rate, unpaid balance and the fair value of the interest rate swap agreements, recognized as cash flow hedging, in existence as of the balance sheet date:
Paying Fixed Interest Receiving Variable Interest Rate Interest Fixed by Contract Unpaid Balance Fair Value As of December 31 As of December 31 2010 2009 2010 2009 2010 2009 % % Thousands of Dollars
Up to one year 4.093 4.105 16,333 99,750 (300 ) (2,659) Between 1 and 2 - 4.093 - 21,000 - (899) years 16,333 120,750 (300) (3,558)
The interest swap agreements are cleared on a quarterly, semiannual or annual basis according to the payoff table of the loan for which the hedging agreement was made. The Group intends to pay off the differences between variable and fixed interest rates on a net basis.
Regarding the Group's accounting policy in the matter of cash flow hedging, see Note 2o.
Interest Rate Swap Agreements Not Recognized as Hedging for Accounting Purposes
In one agreement signed with two banks in Israel, the Libor was fixed for a five-year period (later extended by an additional year), commencing in January 2004, with respect to an opening principal
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amount of approximately $270 million, at graduated interest rates, which declines in accordance with the loan amortization schedule.
In the second agreement signed with a bank in Israel at a premium, the Libor rate was fixed for five years, starting September 2004, with respect to an opening principal amount of approximately $87 million, at graduated interest rates, which declines in accordance with the repayment schedule of the loan. This transaction was carried out at a premium. This agreement was concluded September 2009.
In two additional agreements not recognized as hedging agreements for accounting purposes, conducted with Israeli banking corporations, the Libor variable interest rate was replaced so that a fixed maximum interest rate was set, constituting a hedge against an increase in variable interest rates past this degree, while on the other hand a minimal interest was set, so that if the variable interest rate drops below the minimum level, the Company waives this profit. These transactions were carried out as follows: the first for an opening principal amount of approximately $244 million, gradually decreasing based on a loan amortization schedule over a two-year period starting January 2006. This transaction was concluded in January 2008; and the second, in accordance with a hedging policy for five years forward, on the balance of that same loan, the balance of which will stand at an opening principal amount of approximately $183 million, gradually decreasing based on a loan amortization schedule over a one-year period starting January 2010. This transaction was concluded in January 2011.
In three additional agreements not recognized for accounting purposes as hedging transactions, executed with an Israeli banking corporation, the Libor variable interest rate was exchanged for a fixed rate. These transactions were carried out on an opening principal sum of approximately $276 million, gradually decreasing based on the loan amortization schedules. This was for periods of between one and two years, starting from the second half of 2010. These transactions are expected to reach their conclusion over the course of October 2011, January 2012 and October 2012.
The fair value of these interest rate swap instruments, not recognized as hedging for accounting purposes, as of December 31 2010 is a $21,768 thousand liability (as of December 31 2009, a $20,412 thousand liability).
Interest Rate Swap Agreements Recognized as Cash Flow Hedging for Accounting Purposes
In two additional agreements executed with banks in Israel, the Libor variable interest rate was exchanged for a fixed rate. These transactions were carried out as follows: the first with respect to an opening principal sum of approximately $138 million, gradually decreasing based on a loan amortization schedule over a period of five years and three months starting July 2005 – this transaction was concluded in October 2010; and the second, on an opening principal amount of approximately $40 million, gradually decreasing based on a loan amortization schedule starting October 2005 – this transaction is expected to be concluded in April 2011.
The fair value of these interest rate swap instruments recognized as cash flow hedging for accounting purposes as of December 31 2010 is a $300 thousand liability (as of December 31 2009, a $3,558 thousand liability). Over the course of the year, equity increased by $2,444 thousand after tax, due to the effectiveness of cash flow hedging as protection against cash flow risk due to interest rates (in 2009: an increase in equity after tax of $422 thousand).
Interest Rate Sensitivity Analysis
The sensitivity analysis is determined based on the exposure to interest rates of derivative and non- derivative financial instruments as of the balance sheet date. The sensitivity analysis regarding variable interest liabilities was prepared under the assumption that the sum of the liability as of the balance sheet date remained the same throughout the reported year. For the purpose of reporting on interest rate risk internally to key management personnel, use was made of increases and decreases of 75% (in 2009 – increases and decreases of 75%), representing Management's estimates regarding likely possible changes in interest rates.
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Assuming that interest rates increase/decrease by 75% in 2010 and the remaining parameters remain unchanged, the pre-tax influence was as follows:
a. The profit for the year ending December 31 2010 would increase/decrease by $1,777 thousand and $1,805 thousand, respectively.
b. Capital reserves due to interest hedging rates as of December 31 2010 would increase/decrease by $271 thousand and $273 thousand, respectively.
Assuming that interest rates increase/decrease by 75% in 2009 and the remaining parameters remain unchanged, the pre-tax influence was as follows:
c. The profit for the year ending December 31 2009 would increase/decrease by $9,381 thousand and $9,879 thousand, respectively.
d. Capital reserves due to interest hedging rates as of December 31 2009 would increase/decrease by $142 thousand and $144 thousand, respectively.
g. Jet Fuel Price Risk
The Market Risks Management Committee prescribes the scope and manner of hedging of future consumption of jet fuel (hereinafter: jet fuel). The significance of the financial hedging of jet fuel prices is to guarantee the range of jet fuel purchase prices. In the event of a decrease in jet fuel prices, which is guaranteed beyond the range, then the Company pays the difference. In the event of an increase in jet fuel prices, the Company receives the difference from the guaranteeing company (mainly overseas banks). The goal of the hedge of jet fuel prices is to hedge the Company's exposure to changes in global jet fuel prices. Accordingly, the hedging policy is as follows: hedging amounts of jet fuel up to 24 months forward so that each quarter of the period in question has a minimal hedging rate set from all expected exposure and a maximum hedging rate from all expected consumption in a gradual and descending manner. Accordingly, the maximum hedging rate is 80% and the minimum hedging rate is 20%. The Company is exposed to changes in the fair value of these financial instruments as a result of changes in market prices.
As of December 31 2010, the Company entered into several agreements to hedge jet fuel prices, at 33% of the expected consumption for 2011 and 5% of the consumption expected for 2012.
No material change occurred over the course of the year in jet fuel price risk exposure factors or in the way the Group manages or measures the risk, this due to fuel consumption rates similar to the comparable period last year.
Over the course of the year equity increased by $57,813 thousand after tax due to the effectiveness of cash flow hedging as protection against cash flow risk due to changes in jet fuel prices (in 2009: an increase in equity after tax to the amount of $76,821 thousand).
Over the course of 2010 the Company conducted an in-depth review of its jet fuel hedging policy with the assistance of an outside consulting company. The Risk Management Committee of the Board of Directors discussed the conclusions in the consultants’ report and the Company implemented the recommendations accepted by the Committee. Starting from the second half of 2010 the Company expanded and deepened its capabilities in the field of financial exposure management, while implementing advanced IT systems granting it better capabilities for measuring, analyzing and controlling changes in exposure and in its hedging portfolio. Following this application, in late December 2010 the Company Board of Directors decided to change its financial risk hedging policy, in accordance with the recommendations of the Market Risk Management Committee and Company management. According to the Company's revised policy, the Company will continue to hedge its market risks in the field of jet fuel as follows:
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Jet fuel hedging will be carried out for a period of 12-24 months forward, on a monthly basis and at decreasing rates; For the coming month the Company shall hedge at least 60% of its jet fuel consumption and at most 75%. These percentages will decrease by 5% each month until the 12th month. For the 13-18th months Company management will be given the option of hedging up to 20% of the Company’s expected jet fuel consumption (with no minimum hedging obligation). For the 19-24th months Company management will be given the option of hedging up to 10% of the Company’s expected jet fuel consumption (with no minimum hedging obligation). Hedging shall be carried out using various financial instruments as decided by management (price fixing, options and various option structures), using appropriate base assets such as jet fuel, crude oil or refined oil. At least 20% of the hedging shall be carried out using options, and the balance via options and/or price fixing, at Company management’s full discretion.
Regarding sales and purchase transactions the Company carried out after the report date, see Note 42.
Sensitivity Analysis of Jet Fuel Prices
The following sensitivity analysis was established based on the exposure to fuel price risks on the reported date. Use was made of increase and decrease rates of 15%, which represent Management's estimates regarding possible changes in jet fuel prices.
If jet fuel prices were 15% higher/lower in 2010(2009: 15%), the pre-tax influence would be as follows:
The net profit for the year ending December 31 2010 would be unchanged as all jet fuel hedging transactions open as of December 31 2010 would be recognized as cash flow hedging for accounting purposes (for the year ending December 31 2009: the profit would be unchanged); and
Capital reserves for jet fuel hedging agreements would increase/decrease by $36.3 million as of December 31 2010 (increase/decrease by $46.6 million as of December 31 2009).
Regarding the liquidity risk of the derivative agreements for the reduction of the exposure due to changes in jet fuel prices, see j. below.
Regarding jet fuel price increases subsequent to the reported date, see Note 42. 1.
h. Exposure to the Prices of Capital Instruments of Other Entities
The Group is exposed to risk from the price of shares and options to purchase shares of Maman, presented at fair price as of December 31 2010; see Note 39a. These investments are held for strategic purposes. The Company did not engage in any active trade in these investments. The book value of the investment exposed to the Maman share price risk as of December 31 2010 is $10,324 thousand (the value of the investment in shares is $5,964 thousand, and the value of the investment in options is $4,360 thousand).
Sensitivity Analysis of the Price of Maman Shares
The following sensitivity analysis was established based on the exposure to the price of Maman shares on the reported date. Use was made of increase and decrease rates of 30%, which represent Management's estimates regarding possible changes in the price of Maman shares. If the price of a Maman share was 30% higher/lower on December 31 2010, the pre-tax influence would be as follows: The profit for the year ending December 31 2010 would increase/decrease by $3.9 million and $3.7 million, respectively.
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i. Credit Risk Management
Credit risk refers to the risk of the opposite side failing to meet its contractual obligations and causing a financial loss to the Group.
The Company and its subsidiaries have cash, cash equivalents and long and short-term investments deposited mainly with large, highly rated financial institutions. The Company and its subsidiaries do not anticipate any losses resulting from credit risk.
Most of the revenues earned by the Company and its subsidiaries are derived from a large number of customers (mainly travel and cargo agents), characterized by their dispersal throughout several countries. Exposure to risk from the extension of credit to customers is limited because of their relatively large number and dispersal, as mentioned above. In Israel, insurance on credit (limited in amount) is granted to travel and cargo agents. Overseas agents are covered by collateral to the extent generally accepted in that country. The Company regularly examines customer compliance with credit terms and includes an appropriate allowance for doubtful debts in its Financial Statements.
The carrying amounts of financial instruments listed in the Financial Statements are presented net from devaluation represent the Group's maximum exposure to credit risk, this without taking the value of any security achieved into account.
Regarding the aging of delayed financial assets as of the report date the value of which remains unharmed, see Note 8.
j. Liquidity Risk Management
The ultimate responsibility for liquidity risk management lies with the Board of Directors, which has set an appropriate work plan for management of liquidity risk in relation to management’s requirements for financing and liquidity in the short, medium and long terms. The Company manages the liquidity risk by preserving banking means and loan means, by constant supervision of actual and expected cash flows and adjusting vesting characteristics of financial assets and liabilities. See also Note 36 on means of financing.
Interest and Liquidity Risk Tables
1. Financial Assets and Liabilities Not Constituting Derivative Financial Instruments
The following tables list the Company's outstanding contractual maturities in respect of financial assets (liabilities) that do not constitute financial derivatives. These tables were prepared based on the non-capitalized cash flows, based on the earliest date by which the Group may be required to receive the asset or repay the liability. The table contains cash flows both for interest and for principal.
Fifth Year First Year Second Year Third Year Fourth Year Onward Total Thousands of Dollars As of December 31 2010:
Interest instruments (155,121) (145,054) (179,709) (39,383) (235,072) (754,339)
Trade payables (157,912) (157,912)
Trade receivables 132,960 132,960
Investments in other companies – Maman 10,324 10,324
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As of December 31 2010:
Interest instruments (89,405) (155,294) (145,248) (179,718) (274,500) (844,165)
Trade payables (128,970) - - - - (128,970)
Trade receivables 112,086 - - - - 112,086
2. Derivative Financial Instruments
The following table details the Group's liquidity analysis regarding its derivative financial instruments. The table was prepared based on cash receipts (payments) for derivative instruments repaid on a net basis and non-discount gross cash receipts/payments for those derivatives requiring net payoffs. When the payment or receipt sum is not fixed, the sum for which disclosure was made is set taking into account projected interest rates as described by the interest receipt curve in effect on the balance sheet date. Over 3 Over 1 Months Year and Up to 1 1 to 3 and Up to Up to 4 Month Months 1 Year Years Total Thousands of Dollars
As of December 31 2010: Net Cleared Contracts: Foreign currency swap agreements 1,162 3,800 9,982 - 14,944 Interest rate swap agreements (3,986 ) - (9,726) (9,297) (23,009) Agreements to reduce the exposure from changes in fuel prices 3,063 7,461 22,744 4,864 38,132
239 11,261 23,000 (4,433) 30,067
As of December 31 2009: Net cleared contracts: Foreign currency swap agreements - 1,353 5,723 - 7,076 Interest rate swap agreements (1,537 ) - (7,983) (17,605) (27,125) Agreements to reduce the exposure from changes in fuel prices (3,898) (11,801) (39,544) 2,684 (52,559) (5,435) (10,448) (41,804) (14,921) (72,608)
k. Analysis of Financial Instruments by Linkage Instrument and Type of Currency
As of December 31 2010 In NIS, non- In USD linked Derivative financial assets: Contracts to reduce the exposure from changes in fuel prices 34,311 - Foreign currency swap agreements - 12,170 Other investment – Maman - 10,324 34,311 22,494 Derivative financial liabilities: Fair value via gain/loss Interest rate swap agreements (22,068) - (22,068) - - C 92 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
l. Financial Instruments not Presented at Fair Value in the Balance Sheet:
Other than as set forth in the table below, the Company believes that the book value of the financial assets and liabilities presented at depreciated cost in the Financial Statements are approximately equal to their fair value:
Book Value Fair Value Book Value Fair Value As of As of As of As of December 31 December 31 December 31 December 31 2010 2010 2009 2009 Thousands of Dollars
Long term fixed interest loans (*) 99,103 90,750 108,541 103,735
(*) The long term fixed interest loans include three loans received in April, May and June 2009 for the purpose of financing the purchase of three new 737-800 planes, see Note 22.d.3. The fair value of these loans is based on calculating the current value of cash flows according to an interest rate of 5.66% applied to similar loans with similar characteristics.
m. Financial Instruments Presented at Fair Value in the Balance Sheet:
So as to measure the fair value of its financial instruments, the Group classifies the instruments, measured at fair value in the balance sheet, to one of the following three grades:
Level 1: Quoted prices (unadjusted) in active markets for identical financial assets and liabilities. Level 2: Data not quoted prices included in Level 1, observed, directly (meaning prices) or indirectly (data deriving from prices) as regards financial assets and liabilities. Level 3: Data regarding financial assets and liabilities not based on observed market data.
Classification of financial instruments measured at fair value takes place based on the lowest level in at which material use is made for the purpose of measuring the fair value of the instrument as a whole.
The following are the specifics of the Group’s financial instruments measured at fair value, by level, as of December 31 2010:
Financial assets at fair value: Level 1 Level 2 Total Thousands of Dollars Derivative financial instruments intended for hedging items: Jet fuel hedging agreements - 34,311 34,311 Forward transactions for the purchase of foreign - currency 12,170 12,170 Other investment – Maman 5,964 4,360 10,324 5,964 50,841 56,805
Financial liabilities at fair value: Level 2 Total Thousands of Dollars Derivative financial liabilities intended as hedging instruments measured at fair value: Interest rate swap agreements 300 300 300 300
Financial liabilities measured at fair value via Statement of Operations: Interest rate swap agreements 21,768 21,768 22,068 22,068
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Main assumptions used to establish the fair value of financial instruments:
The fair value of financial assets and liabilities is determined as follows: The fair value of financial assets and liabilities with standard conditions traded on active markets is determined based on quoted market prices. The fair value of other financial assets and liabilities (with the exception of derivatives) is determined using accepted pricing methods based on the analysis of capitalized cash flows analyzed through the use of prices from current observed market transactions and quotes from traders in similar instruments. The fair value of derivative financial instruments is calculated using quoted prices. When such prices are not available, use is made of the analysis of capitalized cash flows while applying the appropriate yield curve for the lifespan of the instruments for derivatives not consisting of options and for derivatives consisting of options use is made of option pricing models.
Note 32 - Statement of Operations Details
a. Operating Revenues:
Composition: For the Year Ending December 31 2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Flying passengers (1) 1,729,115 1,477,409 1,790,769 Less – discounts (18,880) (26,387) (36,471) 1,710,235 1,451,022 1,754,298 Flying cargo and mail 195,100 142,738 266,055 1,905,335 1,593,760 2,020,353 Others 66,904 62,073 75,973 1,972,239 1,655,833 2,096,326
1. The Company recognized $6.7 million in revenues in 2008 for security, fuel and other services surcharges collected from foreign airlines, which up until this date were recognized as a provision, this due to the likelihood that these sums will be required from the foreign airlines. This provision was listed to revenues in 2008, in light of the experience accumulated by the Company in the period of time since they were recognized, which clearly shows that the likelihood that these sums will be required from the foreign airlines is small at best
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b. Operating Expenses:
Composition: For the Year Ending December 31 2010 2009 2008 Thousands of Dollars
Fuel 584,260 475,654 771,192 Salary and associated (including expenses due to employee benefits) 307,537 275,775 303,684 Airport fees and services 159,394 159,973 169,808 Maintenance of aircraft, flight and ground equipment 89,429 91,246 92,517 Air navigation and flight communication 98,168 94,739 100,822 Depreciation 105,333 122,746 107,801 Insurance 6,812 7,139 7,613 Aircraft leasing fees 64,147 53,641 39,340 Meals and supplies 44,192 41,110 42,673 Air crew expenses 44,315 42,415 47,141 Participation in security expenses (see Note 17) 41,068 38,398 43,603 Cost of duty-free products 10,572 10,156 13,158 Other expenses 29,330 31,258 36,977 1,584,557 1,444,250 1,776,329
c. Sales Expenses:
Composition: For the Year Ending December 31 2010 2009 2008 Thousands of Dollars
Agent Commissions 124,887 100,218 137,281 Salary and associated (including expenses due 51,062 47,219 53,913 to employee benefits) Advertising and public relations 11,047 11,547 12,730 Others 27,759 23,978 23,649 214,755 182,962 227,573
d. General and Administrative Expenses:
Composition: For the Year Ending December 31 2010 2009 2008 Thousands of Dollars
Salary and associated (including expenses due to employee benefits) 65,123 57,311 64,856 Professional consultancy 5,574 6,313 6,394 Communications 2,318 3,011 2,876 Rental fees and office maintenance 10,380 10,676 11,083 Insurance 1,993 2,047 2,196 Other expenses 10,765 9,204 9,698 96,153 88,562 97,103
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e. Other expenses (revenues), net:
1. Composition For the Year Ending December 31 2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Expenses in respect of employee retirement plans, net (see Note 23.e and 2 below) 5,106 1,289 9,084 Compensation received (see 3 below)- - (950) Cancellation of provision for productivity incentives - - (11,400) Provision for cargo lawsuit (see Note 27.c.b.1 and 3) 4,264 435 15,427 Capital gains from the realization of fixed assets (see 4 below)(672 ) (582) (7,418) Update of provision due to settlement with income tax (See Note 28f) (22,250 ) - - Depreciation of assets (see Notes 16g and 17c). 1,594 13,714 - Others 689 171 (3,768) Total (11,269) 15,027 975
2. Expenses for employee retirement plans in 2010 mainly include the provision for the retirement plan for 11 employees in 2010 to the amount of $2.0 million (in 2009 a retirement plan was included for 6 employees for whom a $0.8 million provision was made and in 2008 a retirement plan was included for 31 employees for which a provision was made to the amount of $4.6 million). The expense also includes the revaluation of liabilities for existing retirement plans following the revaluation of Israeli currency vis-à-vis the dollar as well as a capitalization coefficient for the retirement plans.
3. As a result of the discontinuation of operations of a company related to Boeing, with which the Company had an agreement in the past to operate internet systems on some of the Company's aircraft, the Company discontinued this service. In January 2007, an agreement was signed between the Company and Boeing, whereby the Company received damages from Boeing for its investments in the Internet system, and for the additional damages it sustained due to discontinuation of the system's operation. Additional compensation was received from Boeing to the amount of $950 thousand in 2008.
4. This section mainly consists in 2010 of capital gains to the amount of $0.4 million from the sale of engine parts of 747-200 airplanes, in 2009 capital gains to the amount of $0.6 million from the sale of two 767-200 engines and in 2008 a capital gains of $4.7 million from the sale of the 767-200 aircraft (marked EAB) and in addition a capital gain of $2.3 million from the sale of two engines.
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Note 33 - Financing Expenses For the Year Ending December 31 2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Loan expenses 13,967 21,532 33,582 Expenses due to interest hedging agreements 11,894 3,797 19,832 Expenses due to the revaluation of Maman options and shares (See Note 39a). 821 - - Expenses due to commissions and other bank expenses 4,024 4,858 2,818 Exchange rate differences due to balances not in the functional currency of the Group 5,205 - 4,618 Others - 110 716 35,911 30,297 61,566
Note 34 - Financing Income
For the Year Ending December 31 2010 2009 2008 Thousands of Dollars
Interest income due to short term bank deposits 1,259 783 7,308
Income from foreign currency hedging agreements 7,902 2,625 8,922 Others 1,688 591 739 10,849 3,999 16,969
Note 35 - Earnings per Share
For the Year Ending December 31 2010 2009 2008 a. Basic Profit per Share
Earnings (loss) per year charged to the shareholders of the parent company (in thousands of dollars) 57,055 (76,300) (41,907)
Weighted average of number of ordinary shares used to compute basic earnings per share (in thousands) 495,719 495,719 495,719
b. Diluted Profit per Share
Earnings (loss) used to calculate diluted earnings per share (in thousands of dollars) 57,055 (76,300) (41,907)
Weighted average of number of ordinary shares used to compute basic earnings per share (in thousands) 495,719 495,719 495,719 Adjustments: Options (in thousands) 1,074 - - Weighted average of number of ordinary shares used to compute diluted earnings per share (in thousands) 496,793 495,719 495,719
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c. Instruments that could potentially dilute basic earnings per share in the future, but which were not included in the calculation of the diluted revenue per share as their influence was anti-diluting:
For the Year Ending December 31 2010 2009 2008
Number of options issued in the framework of share-based payment arrangements (in thousands) 15,545 29,809 16,946
Note 36 - Means of Finance
As of December 31 2010, the Company's credit frameworks amounted to a total of $35 million ($35 million as of December 31 2009). In addition, the hedging institutions provided the Company with unguaranteed frameworks to the amount of $29 million.
Note 37 - Segment-Based Reporting
a . General
The Group has applied IFRS 8, "Operating Segments" (hereinafter "IFRS 8") starting January 1 2009. According to IFRS 8, operational segments are identified based on internal reports on the Group's components, which are reviewed on a regular basis by the Group's chief operational decision maker for the purpose of allocating resources and assessing the performance of the operational segments.
In light of the above, the following are the Company's reported operating segments in accordance with IFRS 8:
Segment A – passenger aircraft activity. Segment B – cargo aircraft activity.
Passenger aircraft activity includes revenues (without deducting discounts) from the transport of passengers including baggage, transporting freight in the holds of passenger aircraft, mail transport and the contribution from the sale of duty free products.
Cargo aircraft activity includes revenues from airborne cargo shipping fees.
The Company’s other activities include revenues from charter flights via subsidiary Sun D'Or (which are written off in the "Adjustments to Consolidated" column), revenues from maintenance service provided to outside elements as well as a broad variety of services and revenues such as equipment leasing, frequent flyer membership fees, loading and unloading services and more.
The Company's chief operational decision maker does not receive reports regarding measurement of segment assets and therefore, in accordance with the revision to IFRS 8, this information is not included in the segment reporting.
In 2009, Company management decided that in determining the results of the reported operating segments, a number of components not part of the direct costs involved in operating the flights, which have been included to date under "unattributed costs", such as depreciation as a result of aviation equipment, fixed maintenance costs and fixed costs at overseas offices must also be allocated. Operating segment results for 2010 as well as comparison figures in this report are presented according to the format set as noted above.
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b. Analysis of revenues and results according to operating segments:
Segment-based earnings represent the contribution made by each segment. Each segment's contribution is determined as follows: revenues created from operating segments less variable expenses involved in the operation of passenger airplane and cargo airplane flights, which include, inter alia, fuel expenses (not including fair value changes of jet fuel hedging agreements); airport fees and taxes, variable maintenance costs, air navigation and communication, passenger food and supplies, aircraft leasing fees, discounts and commissions granted passengers or paid to travel agents, air crew expenses including salaries and variable security costs. Unassigned costs primarily include salary costs (with the exception of air crew costs), changes in the fair value of hedging transactions not recognized for accounting purposes and other fixed costs.
For the Year Ending December 31 2010 Passenger Cargo Adjust- Aircraft Aircraft Others ments Total Thousands of Dollars Revenues Revenues from outside customers 1,765,282 87,508 38,790 80,659 1,972,239 Inter-segment revenues - - 78,573 (78,573) - Total segment revenues 1,765,282 87,508 117,363 2,086 1,972,239
Segment results 251,825 (264) 28,573 - 280,134
Unassigned expenses (192,091)
Operating profit 88,043
Financial expenses (35,911) Financing income 10,849 The Company's share of the profits of subsidiaries, net of tax 45 Profit before taxes on income 63,026 Income Tax (5,971) Yearly profit 57,055
In 2010 the Company attributed depreciation expenses to the amount of $85.4 million to the passenger aircraft segment and $5.6 million to the cargo aircraft segment.
For the Year Ending December 31 2009 Passenger Cargo Adjust- Aircraft Aircraft Others ments Total Thousands of Dollars Revenues Revenues from outside customers 1,489,496 58,317 37,874 70,146 1,655,833 Inter-segment revenues - - 68,051 (68,051) - Total segment revenues 1,489,496 58,317 105,925 2,095 1,655,833
Segment results 112,453 (27,457) 27,457 - 112,453
Unassigned expenses (187,421)
Operational loss (74,968)
Financial expenses (30,297) Financing income 3,999 The Company's share of the profits of subsidiaries, net of tax 442 Loss before taxes on income (100,824) Tax benefit 24,524 Yearly loss (76,300)
- C 99 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
In 2009 the Company attributed depreciation expenses to the amount of $85.8 million to the passenger aircraft segment and $21.2 million to the cargo aircraft segment.
For the Year Ending December 31 2008 Passenger Cargo Adjust- Aircraft Aircraft Others ments Total Thousands of Dollars Revenues Revenues from outside customers 1,832,126 139,474 50,935 73,791 2,096,326 Inter-segment revenues - - 76,350 (76,350) - Total segment revenues 1,832,126 139,474 127,285 (2,559) 2,096,326
Segment results 218,981 (19,305) 44,453 - 244,129
Unassigned expenses (249,783)
Operational loss (5,654)
Financial expenses (61,566) Financing income 16,969 The Company's share of the profits of subsidiaries, net of tax 543 Loss before taxes on income (49,708) Income Tax 7,801 Yearly loss (41,907)
In 2008 the Company attributed depreciation expenses to the amount of $75.7 million to the passenger aircraft segment and $16.6 million to the cargo aircraft segment.
Presentation by Geographical Segments
East and The Rest North Central of the America Europe Asia World Total Thousands of Dollars 2010 Revenues- Segment revenues 673,030 905,582 299,468 50,268 1,928,348 Revenues not attributed to segments 43,891 Total revenues in the consolidated report 1,972,239
2009 Revenues- Segment revenues 547,639 797,327 230,468 38,334 1,613,768 Revenues not attributed to segments 42,065 Total revenues in the consolidated report 1,655,833
2008 Revenues- Segment revenues 712,029 995,984 296,591 46,650 2,051,254 Revenues not attributed to segments 45,072 Total revenues in the consolidated report 2,096,326 - C 100 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Note 38 - Agreements with Related and Interested Parties
a. General
The Company's parent company is K'nafaim Holdings Ltd. (hereinafter “K’nafaim”), which is under the control of the Borowich family.
b. K’nafaim and its Controlling Shareholders
In June 2004, K’nafaim became an interested party in the Company. Starting January 2005 K’nafaim became the Company’s controlling shareholder. As of December 31 2010, K'nafaim holds approximately 39.3% of the Company's shares. The following is a general description of the transactions, their characteristics and scopes: included in the framework of operating revenues in 2010 was revenue of $93 thousand from a member of K’nafaim. No revenues from members of the K'nafaim Group and its controlling parties were included 2009 and 2008.
Within the framework of operating expenses, transactions with K'nafaim and companies in which its controlling parties have a personal interest to the amount of $584 thousand were included in 2010. Expenses totaling $76 thousand were included in 2009 and $156 thousand were included in 2008.
Within the framework of sales expenses, transactions via a third party with Company in which the controlling parties at K’nafaim have a personal interest, in the field of advertising, to the amount of $759 thousand were included in 2010.
Within the framework of general and administrative expenses executive insurance expenses to the amount of $0.1 million were included in 2010 (in 2009: expenses due to executive insurance to the amount of $0.1 million; in 2008: expenses due to executive insurance and management fees to the amount of $0.5 million). Regarding the management agreement, see d. below. Regarding the collective insurance agreement, see g. below.
c. Transactions with additional related and interested parties:
Regarding transactions with additional related and interested parties see r. below.
d. Remuneration of Board members:
On August 6 2008, the Company's Board of Directors decided to increase the remuneration of outside directors as follows: meeting participation remuneration and yearly remuneration to external directors serving the Company shall be paid according to the established sum for a company the Company's grade (Grade D), pursuant to the amendment to the Companies Regulations (Rules Regarding Remuneration and Expenses for External Directors) 2000, published March 6 2008 ("the Remuneration Regulations"). The increase in remuneration sums begins April 1 2008. The fixed sum in question (as increased in the amendment to the Remuneration Regulations) equals 59,100 NIS as yearly remuneration and 2,200 NIS as remuneration for meeting participation. Note that as of this date the external directors were entitled to meeting participation and yearly remuneration according to the sum set in the Remuneration Regulations prior to the amendment.
On October 2, 2008, the Chairman of the Company's Board of Directors, Prof. Israel (Izzy) Borowich announced that he would be resigning his position as Chairman of the Board, in effect November 30 2008.
On December 30 2008 the Company's General Meeting decided to approve for the retiring Chairman of the Board, Prof. Israel (Izzy) Borowich, after his departure, the following rights: (a) one free flight ticket, once per year, for Mr. Borowich and his immediate family (wife and children up to the age of 21) as well as the right to transport personal baggage; (b) an additional three flight tickets per year, at a maximum discount (90%) for Mr. Borowich and his immediate family; (c) ticket per year at a discount of 80% for Mr. Borowich's children over the age of 30; (d) Mr. Borowich's rights and those of his immediate family to free and/or discounted flight tickets and cargo shipping shall be subject to IATA regulations and - C 101 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Company procedures; (e) in the event that service fees are attached for free or discounted tickets or cargo shipping granted to Company employees – these shall apply to the flight tickets mentioned in Sections a- b above; (f) Mr. Borowich's rights and those of his immediate family to reservation arrangements and seating shall be in accordance with Company procedure as regards retiring employees of similar rank and seniority; (g) the Company shall bear no expenses (tax, surcharges etc.) regarding the issue of the flight tickets and/or the flight. It is hereby made clear that there shall be no redundancy of benefits between the entitlement denoted in this decision and the entitlement to flight tickets as director (so long as he continues to serve on the Company's Board of Directors).
In a special General Meeting of the Company's shareholders held on March 4 2009, the following was decided: To increase the financial remuneration to sitting directors and/or directors serving from time to time at the Company, with the exception of external directors, all for the purpose of the execution of their duties as Company directors and all actions deriving from this position, as follows.
a. Remuneration for participation in meetings of the Company's Board of Directors and/or any of its committees at the fixed sum appearing in the third addendum to the Companies Regulations, in accordance with the Company's grade as per the first addendum to the Remuneration Regulations, as determined from time to time. Remuneration for participation in meetings via telecommunications shall be 60% of the remuneration for participation in the meeting and the remuneration for a decision passed without actually convening shall be 50% of the remuneration for participating in the meeting. Yearly remuneration is at the fixed sum appearing in the second addendum to the Remuneration Regulations, in accordance with the Company's grade according to the first addendum to the Remuneration Regulations, as shall be determined from time to time. b. To approve remuneration for Ms. Sophia Kimmerling, considered a controlling party at the Company, for her service as a director at Sun D'Or International Airlines Ltd., a fully owned Company subsidiary, as follows: For participation in meetings of the Sun D'Or Board of Directors and/or of any of its committees at the fixed sum as appears in the third addendum to the Remuneration Regulations, in accordance with Sun D'Or's grade according to the first addendum to the Remuneration Regulations, as determined from time to time. Remuneration for participation in meetings via telecommunications shall be 60% of the remuneration for participation in the meeting and the remuneration for a decision passed without actually convening shall be 50% of the remuneration for participating in the meeting. Yearly remuneration is at the fixed sum appearing in the second addendum to the Remuneration Regulations, in accordance with Sun D'Or's grade according to the first addendum to the Remuneration Regulations, as determined from time to time. Ms. Kimmerling and her spouse shall be entitled to flight tickets on Sun D'Or flights – one ticket per year free of charge and three tickets per year at 10% of the price of a ticket sold online. c. To ratify the employment of Nimrod Borowich, CPA, son of Mr. David Borowich (husband of Mrs. Tamar Moses Borowich) and nephew of Prof. Israel (Izzy) Borowich, a Company controlling shareholder, as manager of a strategic partnership project at the Company in return for a gross monthly salary of 25 thousand NIS and associated benefits, as specified in the employment report attached to the Company's January 22 2009 immediate report.
On January 21 2009 the Company's Board of Directors decided to appoint Mr. Amikam Cohen as Chairman of the Company's Board of Directors, starting February 1 2009.
On April 30 2009 the Audit Committee and the Company's Board of Directors decided to approve the Company's entry into an agreement with the Chairman of the Board - Mr. Amikam Cohen (hereinafter – "the Chairman of the Board") for the provision of Chairman services retroactively starting February 1 2009 (hereinafter: "the Service Agreement"). The Chairman of the Board shall provide the Company with active Chairman services as expected in publicly-owned companies in the field of activity of the Company and of its subsidiaries (hereinafter: "the Services"). In return for the services, the Chairman of the Board shall be entitled to the following remuneration: 1) A monthly salary of NIS 90 thousand plus VAT linked to the CPI (hereinafter – "the Remuneration"); - C 102 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
2) 4,650,000 non-tradable options exercisable as 4,650,000 regular 1 NIS NV shares. The option plan and the service agreement were ratified by the Company's General Meeting on June 24 2009. For details regarding this option plan, see Note 30.g.6. 3) Benefits pertaining to the receipt of flight tickets from the Company; 4) Reasonable expense reimbursements for travel, hosting and mobile telephone expenses made by the Chairman of the Board in the context and for the purpose of providing the services subject to the law and in accordance with Company procedure.
The remuneration and the remaining benefits and payments detailed above constitute full remuneration to the Chairman for the provision of services, including for his services as Company director, and with the exception of these he shall be entitled to no additional benefit and/or wage and/or remuneration from the Company in any form, including directors' salary (participation remuneration and yearly remuneration) for serving as a Company director.
On February 17 2010 the Company's General Meeting approved the extension of the tenure of Mr. Yair Rabinowitz as outside director at the Company for an additional 3 year term, starting March 1 2010, and to ratify the financial remuneration for the outside director, as detailed in the Company's January 6 2010 immediate report.
On March 9 2011 Professor Israel (Izzy) Borowich announced his resignation from the Board of Directors, in light of the Securities Authority (hereinafter: “the Authority”) report (see e. below).
e. The Departing Company CEO:
On September 6 2009, the Company announced that it and its CEO, Mr. Chaim Romano, had reached an agreement according to which Romano's tenure shall end based on 18 months advance notice from the Company in accordance with the personal employment agreement between the Company and the CEO. Until September 30 the date on which this period ended and the balance of the payments was made. The Company's Audit Committee and Board of Directors decided that the non-compete period, which according to the terms of the agreement is 6 months from the completion of work, shall be extended by an additional 12 months, in return for a one-time payment of 750 thousand NIS. In accordance with the terms of the agreement, Mr. Romano was entitled to a retirement bonus equal to one month pay for each year of work at the Company (some five years), in addition to releasing retirement and executive insurance sums at his disposal, as well as the payment of a result-dependent bonus, as established in the employment contract, for the 6 month period from the early notice period. Additional costs resulting from the conclusion of the employment of the CEO (in addition to the sum of 750 thousand NIS for the non-compete grant, as described above) were listed in 2009 to the amount of 3.4 million NIS, which as decided by the Board of Directors was calculated on the basis of January-June 2010. In accordance with the Company’s financial results for this period, the bonus in question amounted to $647 thousand, which was paid in Q3 2010. In addition, the Audit Committee and the Board of Directors decided that the CEO shall be entitled to flight ticket rights, as is general Company practice for a departing executive of the CEO's rank.
On March 10 2011, the Authority provided the Company with an audit report (hereinafter: “the Report”) regarding the terms of the employment of senior Company executives, including the Company's outgoing CEO. In light of the findings of the report regarding the terms of the employment of the outgoing CEO, after an in-depth discussion and re-examination of the approval processes of the outgoing CEO’s employment contract, it was decided that the Company’s authorized institutions re-discuss and ratify the comprehensive bonus sums received by the Company's outgoing CEO for his term in office (March 2005 to December 2009) and its conclusion (hereinafter: “the Bonus Sums”). In its March 9 2011 meeting, after receiving the approval of the Audit Committee meeting March 9, and after studying a draft of the Report dated March 3 2011, the Company Board of Directors discussed the feasibility of the bonus in question in light of the comprehensive remuneration package paid the outgoing CEO for his term in office and its conclusion. On the basis of all of the above, the Company's Audit Committee and Board of Directors decided to ratify the bonus sums paid in practice to the outgoing CEO for his term in office and its conclusion, after a reduction of 4 million NIS (“hereinafter: “the Reduced Sum”). In their decision, the Audit Committee and the Board of Directors stated that taking into account the total sum of the remuneration package paid the outgoing CEO for his term in office and its conclusions, and taking into account the arguments stated above, the bonus sums after the reduction are worthy, reasonable and fair. - C 103 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
f. Agreement with the Company CEO:
On October 21 2009, the Company's Board of Directors decided to appoint Mr. Elyezer Shkedi as the Company's new CEO. Mr. Shekedi began his term in office January 1, 2010. On January 6 2010 the Company’s Audit Committee and Board of Directors approved the terms of Mr. Elyezer Shkedi’s employment as the Company's CEO (hereinafter: “the CEO”), the key points of which are as follows: the CEO shall enter office starting January 1 2010, and shall be subject to the Company's Board of Directors. The CEO's monthly salary shall gross 115thousand NIS, linked to the Consumer Price Index on the basis of the known CPI, with the base index being the CPI published December 15 2009. The CEO shall be entitled to a bonus of a sum composed of the following three components: "Profit bonus" - a sum equal 2.0% of the Company's yearly pre-tax profit appearing in the Company's consolidated and audited yearly Financial Statements "(the Yearly Statements") for each calendar year during the CEO's tenure as Company CEO ("the Tenure"), starting 2010, when such a profit was achieved and for any portion of such a calendar year; as well as - "One-time bonus" - a one-time bonus to the amount of two million NIS for the first calendar year over the course of his tenure, in which the Company achieved a pre-tax yearly profit, in accordance with the Yearly Statements for the year in question ("the Base Year") and (b) an additional (and final) one-time sum of one million NIS for an additional calendar year over the course of the Tenure, in which the Company achieved a pre-tax yearly profit, this in accordance with the Yearly Statements for the year in question; as well as - "A result improvement bonus" - a sum of 2.0% of the aggregate improvement to the Company's yearly pre-tax profit, starting from the base year until the end of the tenure, according to the yearly statements. This bonus shall be paid the CEO for the base year and for each subsequent calendar year in which an improvement occurred (if any) in the yearly profit in question compared to the previous peak year in the tenure, with "previous peak year" in this regard being a previous calendar year, starting from the base year, in which the Company's highest pre-tax profit was achieved to date for which the bonus in question is paid. Eligibility for this bonus shall apply only if (a) a pre-tax yearly profit was achieved for the calendar years during the tenure in accordance with the relevant yearly reports; as well as - (b) under the condition that the profit in question is larger than the pre-tax profit achieved in the previous peak year, and - (c) due to the difference (delta) only between the two profit sums in question (with the exception of for the base year in which the bonus in question is calculated for the entire pre-tax yearly profit for that year). In addition, the Company granted the CEO 9,914,382 options exercisable as 9,914,382 ordinary 1 NIS NV Company shares each (for details regarding the options, see Note 30.g.7). The CEO shall be entitled to social benefits such as executive insurance provisions or pension funds, loss of work ability and education fund, as are commonly granted Company senior executives. In addition, the CEO shall be entitled to 30 paid sick days per year (which may be accumulated to up to 120 days, but not redeemed), 16 recovery days per year, as well as 25 vacation days per year (which may be accumulated, unlimited in amount and redeemable). In addition, the CEO shall be entitled to reasonable personal and hospitality expenses, spent as part of his duties and in return for appropriate receipts/ invoices Upon the discontinuation of the CEO's employment, for any reason, with the exception of criminal circumstances, the CEO shall be entitled to, in addition to the payments specified above, a retirement bonus to the amount of a single monthly salary multiplied by the amount of years he worked at the company (not including the advance notice period), including for a portion of a work year, this according to the CEO's last pay slip. This agreement includes confidentiality and non-compete clauses, according to generally accepted practice, for a 12-month period from the actual discontinuation of work. The Company shall provide the CEO with a mobile phone, a telephone line and home fax machine and shall bear full maintenance and usage costs as well as payments for calls. The Company shall provide the CEO and his household with a Licensing Group 6 vehicle. The Company shall bear all costs involved in the use and maintenance of the vehicle, according to Company practice and its procedures as updated from time to time. The Company shall pay the tax payments borne by the CEO for the vehicle and telephone at his disposal. The CEO shall be entitled to flight tickets for himself and for his family according to Company practice regarding anyone serving as CEO, this according to existing Company procedures, updated from time to time. As part of the negotiations with the CEO regarding the terms of his employment at the Company and at the CEO's request, the Board of Directors approved the establishment of a CEO fund for the remuneration - C 104 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
of excelling employees, to the amount of 2 million NIS. This fund shall be established after the Company's financial results show an improvement of over 50% over 2009. Use of this fund shall be at the discretion of the CEO to provide incentives to excelling Company employees who are not Management members. Based on its 2010 financial results, the Company listed a 2 million NIS expense in its books for the fund.
On March 22 2011 the Company CEO informed the Company Board of Directors, at his own initiative, that he had decided to transfer to the Excellence and People fund, to be established in 2011, a sum equal to 50% of the yearly bonus owed him for 2010, in accordance with the term of his employment, meaning a total of 5.7 million NIS (gross). This sum will be added to a sum of 2 million NIS, which will be deposited in the above fund. The sums in this fund are intended for the development, encouragement and promotion of excellence in the Company and personal excellence, as pertains to all of the Company’s employees in Israel and around the world who are not members of its management.
g. Directors’ and Executives’ Insurance and Indemnification:
Group directors and executives are insured by director and officers' liability insurance in the framework of the insurance coverage prepared by K'nafaim, in accordance with an agreement with K'nafaim.
The General Meeting of Company shareholders, held on May 10 2005, ratified the following decisions:
a. The advance commitment to indemnify executives (no exemption to executives was approved). According to this decision, the extant of the indemnification shall be 25% of the Company’s shareholders’ equity according to its December 31, 2004 Financial Statements or 25% of its shareholders’ equity reported in the last yearly consolidated financial statements prior to the actual payment of the indemnification, whichever is lower. b . Framework agreements for ongoing executive insurance and for run-off executive insurance. The annual premium that will be paid by the Company for self-insurance plus the premiums for run-off insurance will not exceed $450 thousand a year. In October 2006 the executive insurance prepared by K'nafaim was renewed for an additional 18 month period.
On December 9 2009 the insurance was renewed for a period of 18 months, to March 31 2011. In accordance with the terms of the framework agreement, the policy is limited to $100 million as well as an added 20% from the above limit for legal defense expenses in Israel. The Company's share of the insurance fees is a sum of $108thousand a year (relative to an 18 month period - $163thousand), which constitutes 65% of the insurance fees for the group policy. The deductible is between $15 and $75 thousand (according to the type and nature of the suit). The Audit Committee and Company Board of Directors approved the commitment in accordance with Regulation 1(3) of the Companies Regulations (Relief in Transactions with Interested Parties), 2000 and determined that the commitment matches the terms set for the framework transaction, approved by the Company's shareholder meeting dated May 10 2005. The Company is currently acting to renew its insurance.
- C 105 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
h. Aviation insurance agreements:
From time to time the Company enters into aviation insurance agreements with insurance companies which include, among other things, "aircraft body all risks" insurance and "liability" insurance ("the Company's Insurance Policy"). In July 2006 the Company entered into a three-year agreement with the controlling shareholder, K’nafaim, according to which the Company and K'nafaim will jointly approach the Company's insurers with a request to add aviation insurance coverage for K'nafaim within the framework of the Company's insurance policy ("the Original Agreement"). On November 24 2009 and on November 26 2009 the Company's Audit Committee and Board of Directors (respectively) ratified the extension of the original agreement for an additional five years, in which the Company will continue to include insurance coverage for K'nafaim as part of the Company's insurance policy under terms similar to those in the original agreement, as detailed below. The insurance K'nafaim wishes to include as part of the Company's insurance policies is "contingency" insurance for aircraft owned by the K'nafaim group leased to various airlines. This contingent insurance shall only be activated if the aircraft lessees renege on their commitment to purchase insurance for all risks and liabilities or in the event that the lessees' insurers abstain from paying or claim that they have no obligation to pay as well as coverage for ground risks for aircraft of the K'nafaim group. This coverage shall be integrated into the "aircraft body all risks and liabilities" policy prepared from time to time by the Company. In return for the above insurance coverage, K'nafaim shall continue to pay the full premiums required for the added insurance, subject to changes that may apply to insurance fees from time to time in accordance with the extant of the insurance's coverage. In addition, K'nafaim shall continue to pay the Company a sum of 15% from the added premium in question as administrative fees, according to general practice in the insurance industry, and shall bear the added insurance fees in the event of a security incident pertaining to the K'nafaim added insurance. Approval for the transaction was given for a period of up to five years, with the Company reserving the right to revoke the agreement in the event of certain incidents as established in the agreement. In addition, each party shall reserve the right to conclude the agreement for any reason and at its sole discretion, after providing the other party at least 60 days notice. The Audit Committee and the Company's Board of Directors have approved the agreement in question and have determined that there is no material difference between its terms regarding the Company and those regarding K'nafaim, taking into account their relative portions of the shared transaction. Therefore, and in accordance with Regulation 1(4) of the Companies Regulations (Relief in Transactions with Interested Parties), 2000, the Company's entry into the agreement does not required the ratification of the General Meeting with a special majority as per Section 275(a)(3) of the Companies Law, 1999. The K'nafaim added insurance is of an non-material extant in comparison to the extant of the aviation insurance of the Company to which it will be attached and the insurance coverage does not harm the Company. The added premium for the K'nafaim aviation insurance, paid be K'nafaim, was priced separately by the insurers and matches the relative value of this added insurance compared to the total value of the insurance to which it is attached. Nothing in the added insurance from K'nafaim shall cause the Company to pay higher premiums not covered in full by K'nafaim. In addition, K'nafaim shall continue to make additional payments to the amount of 15% of the insurance fees for the inclusion of the insurance in question, as set in the past in accordance with the recommendation of an agreed-upon outside insurance consultant, as payment acceptable in the aviation industry as administrative fees. In light of the above, the terms of the policy as regards the Company are not materially different from its terms regarding the controlling shareholder taking their relative portion into account.
i. Fees of Executives who are Not Directors or CEO:
A Special Meeting of Company Shareholders, taking place on July 14, 2005, resolved to add Regulation 158a to the Company’s bylaws. The added regulation states, among other things, that the fees of executives (not including directors who are not Company employees, other than the CEO, a controlling party, a relative of a controlling party or an interested party in a controlling party), when the issue does not entail an irregular transaction, shall be approved by the Human Resources and Appointments Committee of the Board of Directors.
- C 106 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
j. In a special General Meeting of the Company's shareholders held on June 24 2009, the following was decided:
1. To approve the Company's entry into a service agreement with the Chairman of the Company's Board of Directors – Mr. Amikam Cohen, as per Note 38d above. 2. To ratify the appointment of Mr. Pinchas Ginsburg as Director on the Company's Board of Directors for tenure to conclude with the Company’s next annual General Meeting. 3. To ratify Amendment 110 to the Company's Articles, regarding the increase of the maximum number of directors in the Company's Board of Directors. 4. To ratify the appointment of Mr. Shlomo Hannael as member of the Company's Board of Directors for a tenure to conclude at the Company’s next annual General Meeting.
On January 19 2011 the Company’s General Meeting ratified the continuation of the tenures of the directors serving on the Company's Board of Directors (who are not external directors) as follows: Amikam Cohen, Tamar Moses Borowich, Yehuda (Yudi) Levi, Professor Israel (Izzy) Borowich, Amnon Lipkin-Shahak, Amiaz Sagis, Nadav Palti, Eran Ilan, Pinchas Ginsburg and Shlomo Hannael as well as the appointment of Ms. Sophia Kimmerling as member of the Company's Board of Directors, until the conclusion of next annual General Meeting.
k. Negligible Transaction
On November 26 2009, the Company Board of Directors decided to adopt rules and guidelines for the classification of a transaction made by the Company or one of its affiliates with an interested party (hereinafter: "an Interested Party Transaction") as a negligible transaction as defined in Regulation 64(3)(d)(a) of the Securities Regulations (Preparation of Yearly Financial Statements), 1993 or as defined in Regulation 41(a)(6)(a) of the Securities Regulations (Yearly Financial Statements), 2010 which replaced the regulations in question starting January 6 2010. These rules and guidelines are also used to determine the extant of disclosure in the periodic report and in the prospectus (including in shelf proposal reports) as regards transactions with controlling shareholders or in which controlling shareholders have personal interest as defined in Regulation 22 of the Securities Regulations (Periodic and Immediate Reports), 1970 (hereinafter: "the Reporting Regulations), and Regulation 54 of the Securities Regulations (Prospectus Details and Prospectus Draft – Structure and Form) as well as to determine the need to submit an immediate report for such a transaction, as set in Regulation 37(a)(6) of the Reporting Regulations. The Company's Board of Directors has determined that in the absence of special qualitative considerations deriving from the circumstances of the issue, an Interested Party Transaction shall be considered a "negligible transaction" if: (a) The transaction takes place over the Company's normal course of business and (b) the transaction is under market conditions and its terms are acceptable to the relevant market; and (c) the relevant criteria for the transaction, one or more, whether it is a single commitment or a series of commitments on the same issue over the course of the same year, is no greater than 200 thousand NIS in any interested party transaction the classification of which has been considered as a "negligible transaction" on the basis of the Company's latest audited consolidated yearly financial statements. Relevant criteria for the determination of a transaction are, for instance: (1) total sales the subject of the Interested Party Transaction; or - (2) the total cost of the sales the subject of the Interested Party Transaction; or – (3) the extant of assets the subject of the Interested Party Transaction; or – (4) the extant of liabilities the subject of the Interested Party Transaction; or – (5) the extant of the expense or yield the subject of the Interested Party Transaction. In this regard – in the event the Company does not have full rights to a certain transaction, the transaction shall be determined based on the Company's relative portion of the transaction. In cases in which, according to the Company's judgment, all of the aforementioned criteria are irrelevant for the determination of the negligibility of the Interested Party Transaction, the transaction shall be considered negligible, in accordance with a different relevant criterion, determined by the Company, so long as the relevant criterion used for this transaction shall not exceed 200 thousand NIS. At the same time, examination of the quantitative considerations of an interested party transaction may lead to the contradiction of the aforementioned fixed presumption of the transaction's negligibility. Thus, for instance, and merely as an example, an Interested Party Transaction shall not generally be considered negligible if it is considered a significant event by Company Management and if it serves as the basis for
- C 107 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
administrative decisions, or if interested parties are expected to receive benefits that need to be reported to the public pursuant to the transaction. The transaction's negligibility shall be determined on a yearly basis for the purpose of reporting within the framework of the periodic report, the financial statements and the prospectus (including a shelf proposal report), while adding together all of the Company's transactions of the sort with the interested party in question or with corporations under the control of the interested party. To be clear – separate transactions carried out on a regular and repeating basis during a certain period with no mutual dependence or for which no additional obligations exist which are not relevant to entering into the transaction as regards the same interested party, shall be examined on a yearly basis for the purpose of reporting pursuant to the periodic report , the financial statements and the prospectus (including a shelf proposal report), and on the basis of the specific transaction for the purpose of immediate reporting. Over its regular course of business, the Company carried out, during the reported year or as of the date the report was filed or still in effect as of the report date, transactions with controlling shareholders defined as “negligible transactions” of the following types and with the following characteristics: catering services for passengers whose flight has been delayed; entering into an agreement to direct search engines to the Company’s website; purchasing books for frequent flyer club members; security screening services for VIP travelers in the Massed Lounge; as well as undercover inspections on Company flights and during security screening for Company flights.
l. Agreement with QAS
On November 22 2010 the Company signed an agreement with QAS Israel Ltd. (“the Agreement” and “QAS”, respectively), 50% of the shares of which are held by the Company’s controlling shareholders, K’nafaim. According to the Agreement, the Company shall provide QAS with ground services at Ben Gurion Airport in return for a payment reflecting the market price for similar services, at non-material amounts. QAS deals in the supply of ground services to foreign airlines at Ben Gurion Airport and is interested in the Company carrying out some of the services QAS provides the airlines, such as towing aircraft, providing electrical power to aircraft and providing aircraft accessories. The agreement is for an unlimited term and each party may terminate it with 60 days notice. This agreement was approved by the Company Board of Directors as a non-exceptional transaction. The key points of the Board of Directors’ argument for approving the agreement were the increase in the volume of activity in the field of maintenance, and increased market share and improved profitability for the Company.
m. Additional Commitments
Commitments for the receipt of additional services, over the normal course of business, under generally accepted conditions and market prices, via the Company's advertising agency, from the Yediot Acharonot Group and from a billboard advertising sales enterprise. In addition, a commitment for the purchase of newspapers and magazines belonging to the Yediot Acharonot Group.
Yediot Acharonot Ltd. is a company under the control of Arnon (Noni) Moses, brother of Ms. Tamar Borowich, Deputy Chairperson of the Company’s Board of Directors and controlling shareholder at K’nafaim. The billboard advertising sale enterprise (hereinafter: “the Enterprise”) is operated by CTV Media Israel Ltd. (hereinafter: “the Advertising Company”), Communicative Ltd. (the Advertising Company’s controlling shareholder) and C Vision Billboards Ltd. The Advertising Company and/or Communicative Ltd. are entitled to 60% of the Enteprise’s revenues. Mr. Tamar holds indirectly, linked via other companies, 26.2% of the issued capital of the Advertising Company (in practice her theoretical share of the Enterprise is 15.7%); Mr. Nadav Palti, who serves as a Company director, holds indirectly, linked via other companies, 9.2% of the issued capital of the Advertising Company (in practice his theoretical share of the Enterprise is 5.5%); Professor Israel Borowich (the controlling shareholder of K’nafaim) holds shares constituting 0.29% of Communicative Ltd.’s issued capital. Mr. Tamar Borowich and Mr. Nadav Palti serve on the board of the Advertising Company.
On March 22 2011 the Company's Board of Directors approved a yearly framework for the commitment detailed above, ratified for prudence’s sake the commitments made in 2008, 2009 and 2010 and set mechanisms to supervise the upholding of the commitment’s framework conditions and their execution under market conditions and prices. The commitments were classified by the Company as non- exceptional transactions. - C 108 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
On January 21 2009 the Company's Board of Directors approved a commitment with the law firm of Goldfarb, Levi, Eran, Meiri, Tzafrir & Co. for the treatment of various legal issues. The commitment was brought to the approval of the Board of Directors as a non-exceptional transaction as the Company's controlling shareholder, the Deputy Chairman of the Board. Yehuda (Yudi) Levi, esq., has a personal interest, as he is a managing partner of the law firm in question. The Company’s Board of Directors discussed the matter and approved that as the Company has regular contingency agreements with a number of law firms for the receipt of legal services in a variety of fields, this constitutes a commitment over the normal course of the Company’s business that does no harm to the Company. Furthermore, hourly fees are as accepted in the Company’s commitments with law firms handling various issues and therefore the commitment is under market conditions.
n. Transactions between the Company and Board member Pinchas Ginsburg (hereinafter: “Ginsburg”) or persons operating on his behalf (including corporations under his control):
Pinchas Ginsburg (serving on the Company's Board of Directors) and I. Hillel & Co. Ltd. (“I. Hillel”), in his full possession, received the approval of the Holder of the Special State Share on September 3 2006 according to which the Holder agrees that individuals members of Pinchas Ginsburg’s family and I. Hillel may hold the Company’s shares together at a rate lower than 15% of the Company’s issued stock value. Note that Pinchas Ginsburg has a personal interest, directly or indirectly, in various transactions carried out by the Company and/or related companies, as detailed below: (a) I. Hillel carries out, from time to time, transactions with the Company and with Sun D’Or for the purchase of flight tickets for Company and Sun D’Or flights as well as Sun D’Or charter flights; (b) Sun D’Or enters, from time to time, into transactions with Air Tour, half of the shares of which are held by the Company and the other half are held, to the best of the Company's knowledge, by travel agents, including I. Hillel. Mr. Ginsburg also serves on the Board of Directors of Air Tour. These transactions are essentially the purchase of flight tickets, providing outsourcing services by Air Tour in ticketing areas, making reservations and providing ground services; (c) Pinchas Ginsburg acts as the general sales agent for Thai Airways (“Thai”) in Israel. Ginsburg’s compensation is based on commissions deriving from the sale of Thai flight tickets in Israel. Agreements are in place between the Company and Thai regarding the transport of passengers and the transport of cargo, including code sharing and interline agreements. In light of Mr. Ginsburg’s personal interest in all of the transactions in question, the Company's Board of Directors approved, as non-exceptional transactions, the transaction procedure pertaining to commitments between the Company and Thai as well as the transaction procedure between Sun D’Or and Air Tour as well as framework agreements between I. Hillel and/or Mr. Ginsburg (in this section – “the Interested Party”) and the Company and Sun D’Or (all of the transactions in question shall hereby be referred to as “the Commitments”). The basic principles of the transaction procedures and framework agreements are as follows: (1) once per year the Company’s Board of Directors shall set the maximum yearly proceeds for transactions with the interested party (hereinafter – “the Maximum Sum”); (2) all commitments pursuant to the maximum sum shall be at market prices and under market conditions; commitments not under market conditions shall require the advance approval of the Audit Committee and Company Board of Directors; (3) a supervising element shall be appointed to ensure that all of the commitments are carried out under market conditions and who shall provide the Company's Audit Committee, on a biannual basis, with a written report regarding commitments carried out in the previous half and their conditions; (4) insomuch as the Audit Committee determines that a deviation had occurred from market prices and conditions in any of the commitments (“Deviating Commitments”), the discussion of these Deviating Commitments shall be passed on to the Company’s Board of Directors for its approval regarding its decision on the steps required for their approval. Note that as of this report, no deviating transactions have been found; (5) extending the commitments shall be subject to the approval of the Company's authorized organs.
- C 109 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
o. Remuneration of Key Management Personnel
For the Year Ending December 31 2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars
Short-term benefits 8,252 4,516 4,822 Post-employment benefits 1,266 1,460 1,456 Share-based payment 745 515 837 10,263 6,491 7,115
p. Benefits Granted Interested Parties 2010 2009 2008 Thousands of Thousands Thousands Dollars of Dollars of Dollars
Salaries and ancillary expenses to interested parties employed in the Company - 15 16 Number of individuals to whom the benefit relates - 1 1 Chairman services and commissions fees (including bonuses due to options)to interested parties employed by the Company 411 464 376 Number of individuals to whom the benefit relates 1 1 1 Remuneration of directors not employed by the
Company 404 333 87
Number of individuals to whom the benefit relates 11 13 10
q. Balances with Interested and Related Parties
As of December 31 2010 2009 Thousands of Thousands of Dollars Dollars
Other interested parties /related parties
Within the framework of current assets -
Trade receivables Related party – affiliated company (in dollars) 3,522 2,417 Related party and interested party (in dollars) 564 71 4,086 2,488
Total highest debit balance during the balance year 10,758 5,264
In the framework of current liabilities -
Trade Payables
Related party – affiliated company (in dollars) - 7 Related party and interested party (in NIS) 366 49 366 56
- C 110 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
As of December 31 2010 2009 Thousands of Thousands of Dollars Dollars Current Liabilities due to Employee Benefits
Related party 3,213 1,379
Subsidiaries
In the framework of non-current financial assets -
Investment in shares - 57 - 57
r. Transactions with Interested and Related Parties 2010 2009 2008 Thousands of Thousands of Thousands of Dollars Dollars Dollars Interested Parties/Related Parties
Revenues from interested and related parties
Flight tickets 35,972 34,040 22,801 Cargo transport 20,447 16,219 34,014 Maintenance services 93 - - Use of software (affiliated company) - 100 1,696
Financing (from affiliated company) - 17 52
Operating Expenses - Transactions with controlling party 584 76 156 Services from interested party 332 - -
Sales Expenses - Primarily commissions and marketing fees 3,326 5,574 8,853 (affiliated company) Primarily agent commissions (to interested 63 110 136 parties) Advertising services from interested party (via 759 - - third party)
General and administrative expenses 5,835 2,843 1,980
Note 39 - Material Transactions and Events During the Reported Period
a. Framework Agreement with Cargo Terminals and Handling Ltd. ("Maman")
On April 12 2010 the Company announced that it had signed an agreement paper ("the Agreement Paper") with Maman, according to which, subject to the ratification of its General Meeting and the approval of the Stock Exchange, options shall be allocated by Maman to a trustee ("the Trustee Options") exercisable as Maman shares, in lieu of allocation to the Company of first and second portion shares as defined in the framework agreement. It was also agreed that subject to the receipt of the approvals in question, the trustee shall be provided with the options Maman undertook to grant the Company in accordance with the framework agreement ("the Options in the Agreement").
The Agreement Paper states that the Trustee Options shall be exercised and converted to first and second - C 111 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
portion shares and that the trustee shall provide the Company with the Options in the Agreement, on the earlier of the following two dates: (a) August 31 2010, so long as no decision is reached by the Israel Antitrust Authority according to which the allocation of first and/or second portion shares constitutes a restrictive arrangement or misuse of a monopoly; or (b) the date on which approval is granted by the Israel Antitrust Authority according to which is believes that nothing in Restraint of Trade law precludes the allocation of the shares and options in question or that it does not intend to take any action pertaining to the allocation of shares and options in question, or that it was stopping its investigation into the matter of the framework agreement. Prior to the date in question no use shall be made of the Trustee Option and of the Options in the Agreement and no shares shall be allocated as a result. The trustee agreement in question was adopted by the parties after the Israel Antitrust Authority informed Maman and the Company that the arrangements included in the framework agreement on the matter of the allocation of shares and discounts could apparently constitute a restrictive arrangement and misuse of a monopoly, in accordance with the Restrictive Trade Practices Act, 1988, and in light of this proposed that the parties avoid acting in accordance with the Framework Agreement. The trustee mechanism in question was adopted in order to provide the Israel Antitrust Authority with additional time for the purpose of examining the framework agreement and formulating its conclusions in our matter.
On April 14 2010 the Company received notice from the Israel Antitrust Authority that establishing a trustee, transferring options to the trustee and establishing a date for their exercise in accordance with the Agreement Paper are not compatible with the position of the Israel Antitrust Authority and that such an action may constitute a violation of the Restrictive Trade Practices Act, 1988 by the parties, their executives and the trustee appointed in accordance with the Agreement Papers and exposes them to means of enforcement resulting from the law in question. Following a request by the Restraint of Business Authority as described above, no allocations of securities as per the framework agreement were made at the time.
On September 13 2010 the Company received a letter from the Restraint of Trade Authority, according to which the Authority confirmed that the wording of the clause (as detailed above) included in the draft addition to the framework agreement provided by the Company and Maman to the Restraint of Business Authority, is acceptable, and that after the parties sign the addition to the framework agreement including the clause in question, the Restraint of Business Authority will have no objections to the implementation of the framework agreement. The clause of the addition draft to which the Restraint of Business Authority refers in its letter sets various restrictions, as required by the Authority, on the Company's involvement in the affairs of a specific Maman subsidiary (Laufer Aviation GHI Ltd.) and on the transfer of certain information pertaining to the subsidiary in question to the Company.
On September 19 2010 the Company and Maman signed an addition to the framework agreement, the signing of which constituted a term for the removal of the Restraint of Business’s objections to the implementation of the framework agreement.
On November 3 2010 Maman’s special general meeting approved a material private offer, pursuant to which Maman’s securities would be allocated to the Company in the following manner: up to 7,000,000 regular 1 NIS NV each shares constituting up to 15% of Maman’s issued and paid-up capital, as well as options exercisable as regular shares at a rate close to 10% of Maman’s issued and paid-up capital. Following this, as of December 31 2010 the Company was issued 2,837,837 ordinary Maman shares, constituting 7.5% of Maman’s issued and paid-up capital, as well as the aforementioned options. Furthermore, the general meeting approved the appointment of Mr. Amikam Cohen, Chairman of the Company's Board of Directors, as member of Maman’s board of directors, starting November 7 2010 and the appointment of Mr. Yehuda (Yudi) Levi, Deputy Chairman of the Company’s Board of Directors, as member of Maman’s Board of Directors, starting January 1 2011. On November 1, 2010, the Company informed Maman of the extension of the option to extend the commitment period according to the framework agreement, this up to December 31 2011. As a result of the completion of the transaction, in 2010 the Company listed in its books receipts to the amount of $4.2 million for discounts received pursuant to the Maman transaction, and an additional $6.2 million for the allocation of 7.5% of Maman’s shares to the Company for no return. These sums reduced the Airport Fees and Services item under operating expenses in the Company’s Statement of Operations. Changes in the fair value of the shares are charged to the gain/loss up to the date on which the Company
- C 112 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
will have a material impact on Maman (as a result, in Q4 2010 financing expenses were charged to the amount of $0.2 million). The fair value of the options exercisable as ordinary shares close to 10% of Maman’s issued and paid-up capital was estimated using the Black & Scholes Model. The value of the options, based on the following parameters, as of the allocation date of November 7 2010, amounted to 17.5 million NIS ($4.8 million on that date). This sum reduced the Airport Fees and Services item under operating expenses in the Company’s Statement of Operations.
The parameters used in the application of the model, as of November 7 2010, are as follows:
Share price (in NIS) 0.801 Exercise price (in NIS) 0.624 Expected fluctuation (*) 39% Lifespan of options (in years) 6 Risk-free interest rate 3.4% Expected dividend rate 0%
(*) The expected fluctuation is determined based on historic fluctuations in the price Maman’s share during a three-year period.
The options are treated as a derivative, with the changes in fair value charged to the gain/loss (as a result, in Q4 2010 financing expenses were charged to the amount of $0.6 million). In both 2011 and 2012 the Company is expected to receive an additional 3.75% of Maman’s shares, subject to the realization of the terms of the agreement. In January 2011 the Company was allocated an additional 1,598,783 shares, constituting 3.75% of Maman’s issued and paid-up share capital, so that the Company’s total holdings after this allocation amount to 11.25% of Maman’s issued and paid-up share capital.
b. The Minister of Transportation's decision to approve scheduled flights to Eilat:
Regarding the Company's appointment as designated carrier to Eilat, on February 4 2010 the Minister of Transportation accepted the recommendations of the CAA and issued his authorization to the Company to operate scheduled flights between BGN and Eilat. According to the Minister's decision, the Company may operate three daily flights in either direction between BGN and Eilat on five out of seven days a week, offering no more than 430 seats per day in each direction. In addition, the Company shall be required to operate at least one daily flight in each direction, five days a week, and offer 100 seats in each direction at least on all flights and separate between the frequent flyer programs operated by the Company on international lines and domestic services. Concurrently with the decision allowing the Company to fly to Eilat, the Minister of Transportation decided to release Israir from its flight schedule and seat obligations and allow it to set its flight schedule between Sdeh Dov and Eilat and between BGN and Eilat according to its own priorities. The Minister of Transportation's decision was set for a six month period starting from the beginning of flights by the Company. At the end of the period the Company's entry into the route shall be examined and requisite changes, if any, will be decided upon accordingly. As noted above, the beginning of flights will be postponed by 30 days from the date of the Minister's approval in order to allow Arkia and Israir to approach the court with a repeat petition to revoke the approval granted El Al regarding the flights on the Eilat route.
On March 8 2010 Arkia filed a petition before the High Court of Justice against the Minister of Transportation and Road Safety, the Civil Aviation Authority and the Company (hereinafter: "the Respondents") and on March 9 2010 Israir filed a similar petition before the court. In these petitions the court was asked to issue a temporary order instructing the Respondents to explain why exactly the Minister of Transportation's Authorization on February 4 2010 to allow the Company to operate direct flights between Ben Gurion Airport and Eilat should not be revoked. In addition, the court was asked to issue an interim order (or alternately an injunction until a hearing is held on the petition) instructing the Respondents to avoid realizing the decision until the petition is resolved.
The Supreme Court did not issue an interim order in response to the petitions filed by Arkia and Israir and the court consolidated the petitions. - C 113 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
On March 10 the Company filed a petition to the High Court of Justice against the decision by the Minister of Transportation on the matter of the license granted the Company to operate the Eilat route ("the Decision"), pursuant to which a temporary order was requested instructing the Minister of Transportation and the Head of the Civil Aviation Authority to explain why the Court should not rule that the restrictions placed on the Company in the Decision be cancelled, including the restrictions involving the frequency of flights and amount of seats, minimum flight requirements and the requirement that the Company's international frequent flyer plan be separated from its domestic frequent flyer plan, as well as why the court should not instruct them to clarify why the Company's license needs to be reexamined after a period of six months.
On June 27 2010 the High Court of Justice ruled to reject the petitions filed by Arkia and Israir against the ruling, and ruled to reject the petition filed by the Company on the matter of the terms set in the decision, and charged the petitioners for court expenses.
In August 2010 the Company began operating 3 daily flights on the BGN-Eilat route, in accordance with the conditions set in the resolution of the Minister of Transportation and Road Safety. In August- December 2010, the Company flew 96,000 passenger legs and its share of domestic traffic to Eilat was in this period was 16%.
c. The Eruption of the Volcano in Iceland
Following the eruption of the volcano in Iceland and the diffusion of volcanic dust through European skies, starting April 15 2010 most European airports gradually closed to air traffic, this in accordance with European aviation authority directives. European airspace was completely closed for 6 days with thousands of flights cancelled a day. In addition, restrictions were placed on takeoffs, landings and aviation traffic in and around Europe. These events caused financial damage to the global economy and to the aviation industry in particular. The events in question also had an impact on the Company's European activities and led to the cancellation of dozens of flights to various European destinations. The Company continued with scheduled activity to its destinations in America, Asia and South Africa and reinforced its flights to European airports open for traffic. In light of the short duration of the event, it had no material impact on the Company’s operating results.
d. Aircraft Leases
1. On March 28 2010 the Company signed an agreement for the lease of a Boeing 747-400 aircraft (ELF), manufactured in 1994 ("the Agreement" and "the Plane", respectively), with an Irish aircraft leasing company. According to the agreement, the leasing period is from the date of the aircraft's receipt until June 30 2012 with the option (held by the Company) to extend the lease for an additional 36 month period. Note that during the period between April 2010 and the end of June 2010, the leasing fees were paid relative to the Plane's operation, in accordance with the commercial understandings achieved between the parties. In addition, pursuant to the agreement, the Company was granted the right of first refusal and options to purchase the aircraft, in accordance with the agreements between the parties. The Plane was received on April 24 2010. In accordance with the terms set in the agreement, the lease was classified as an operational lease.
2. In May 2010 the Company signed a contract with the International Lease Finance Corporation to lease a 767-300ER aircraft (EAK) for a lease period of 65 months. The plane, manufactured in 1997, was received by the Company on June 21 2010 and began service on July 11 2010. The lease was classified as an operational lease in the Financial Statements.
3. In July 2010 the Company decided to exercise its option to extend the lease of a K.M.A.S. Aviation 757-200 aircraft (EBM), starting December 2010, for an additional 12-month lease. The lease was classified as an operational lease in the Financial Statements.
4. In August 2010 the Company signed an extension and a revision to the lease for the 737-800 aircraft (EKP), manufactured in 2001, from the International Lease Finance Corporation (“ILFC”), with whom a memorandum of understanding regarding the aircraft in question was signed in May 2010. The aircraft shall be leased for an additional 45 months. The lease was classified as an - C 114 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
operational lease in the Financial Statements.
5. In October 2010 the Company signed an agreement to lease a 737-800 aircraft (EKT) from Wilmington Trust Sp Services (Dublin) Limited, which holds the plane in trust for CIT Aviation Finance Limited, with whom a memorandum of understanding was signed in July 2010 regarding the aircraft in question. The agreement includes the aircraft’s lease for an additional 68 months, with an option to extend the lease by an additional 24 months. The aircraft, manufactured in 2006 shall be reconfigured to El Al configuration upon receipt. The agreement was revised and the lease period extended due to the fact that the delivery of the aircraft was pushed forward from March 2011 to January 2011. The lease shall be classified as an operational lease in the Financial Statements.
6. In October 2010 the Company signed an extension and revision to the agreement to lease a 737- 300ER aircraft (EAP), manufactured in 1991, from CIT Aerospace International for an additional 42 months with the option to shorten the additional lease period to 18 months. The lease shall be classified as an operational lease in the Financial Statements.
7. In October 2010 the Company signed an extension and a revision to the lease for the 737-800 aircraft (EKO) manufactured in 2003, from RAIN VI LLC with whom a memorandum of understanding regarding the aircraft in question was signed in May 2010. The aircraft shall be leased for an additional 5-year period with an option to shorten the additional lease period to 3 years. The lease was classified as an operational lease in the Financial Statements.
8. In January 2011 the Company signed an extension and revision to the agreement to lease a 737- 300ER aircraft (EAR), manufactured in 1995, from International Lease Finance Corporation for an additional 60 months with the option of shortening the additional leasing period after 36 months. The lease was classified as an operational lease in the Financial Statements.
9. In February 2011 the Company signed an agreement to lease a 767-300ER aircraft from A. I. AWMS Delaware Statutory Trust, with whom a memorandum of understanding was signed in November 2010 regarding the aircraft in question. The aircraft is leased for a period of 78 months and an early departure option has been granted each of the parties after 54 months. The aircraft was manufactured in 2000 and is expected to join the Company's aircraft fleet in late March 2011.
e. Changes to Fuel Tanks of Company Aircraft
The U.S. aviation authorities have required the Company to perform alterations on the fuel tanks of the Company's planes. The cost of the change amounts to a total of $9.3 million. The change must be carried out on one half of the aircraft by the end of 2014, with the end date for all aircraft set for the end of 2017. Over the course of 2010 the Company ordered 3 kits at a cost of $1.1 million to carry out the change on 3 aircraft. The kits are expected to arrive over the course of 2011, and shall be installed in the aircraft after their arrival. Over the course of 2011 the Company is expected to order an additional 5 kits, to be carried out in 2012, at a cost of $1.8 million.
Note 40 - Transactions and Commitments with Investees
1. As stated in Note 1c. The Company did not include separate financial information in its 2010 and 2009 Financial Statements in accordance with Regulation 9c. of the Regulations, due to the negligibility of the added information. The Company fully owns several companies the activity of which complements the primary activity conducted within the framework of the Company. These companies do not act independently, but are in effect specific components of the Company's array of activities consolidated in the form of companies and this from regulation and other administrative reasons (salary agreements etc.). These companies are not material relative to the Company as the extant of assets, liabilities and revenues managed as part of the subsidiaries are negligible relative to the extant of the assets, liabilities and revenues managed within the framework of the Company. Therefore, publication of separate Financial Statements will not provide additional material information to the reasonable investor.
- C 115 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
2. The Company has entered into agreements with its subsidiaries as follows:
a. Activity between the parent company and its subsidiaries Yearly Investment Credit/Debit Account Company Type of Activity Turnover Account as of Dec. 31 Dec. 31 2010 2009 2010 2009 2010 2009 Thousands of Dollars Leasing of aircraft and associated Sun D’Or services. 78,573 68,051 3 3 9,631 6,543 Commissions 878 648 Purchasing food for Company flights TAMAM from BGN 21,519 19,608 756 1,617 3,641 4,310 Purchasing food for Company flights Borenstein from New York 5,990 6,352 4,491 4,367 178 191 Dividend 20 - Managements fees 184 188 Loan to parent company (1) 2,600 2,600 Superstar Sale of flight tickets 10,547 8,578 (65) (32) 104 189 Loans from parent company (2) 488 332 Purchasing food for employees and food services in the King David Katit Lounge in Terminal 3 3,064 2,767 - - 1,221 946
(1) In December 2008 the Company received a $2,600 thousand loan from Borenstein for a period of three years, at a 2.3% annual interest rate paid December 15 every year. In 2010 the Company's interest expenses for this loan amounted to $60 thousand (in 2009, $60 thousand). (2) In September 2007 the Company provided Superstar with a £205 thousand loan. In October 2010 the Company provided an additional with a £110 thousand loan. The two loans have no repayment date and bear no interest.
b. Mutual activity between subsidiaries Credit/Debit Account as Company Type of Activity Yearly Turnover of 2010 2009 31.12.2010 31.12.2009 Thousands of Dollars Thousands of Dollars TAMAM-Katit Food purchasing 34 58 10 20 Flight Ticket Superstar-Sun D'Or Purchasing 3,494 2,095 428 788
Note 41 - Liens and Collateral
As stated in Note 16i above, the Company's assets free of liens as of December 31 2010 are aircraft and reserve engines worth $23 million as well as parts and other fixed assets to the amount of $1142 million. With the exception of these assets, the assets are restricted in favor of loans granted by the lending banks. The following details the Company’s liabilities secured by liens: Plane Type of Register Year of Plane Code Manufacture Lien Details Fixed and specific first-tier pledge and lien for an Israeli bank on all of the Company's rights to the planes. The pledge and lien include all the engines, the rights deriving from the lease or use of the aircraft or contracts or insurance policies and rights to ECA 777- indemnification or insurance proceeds for the aircraft in question. In addition, a first- ECB 2001 200ER tier floating lien was registered on all the engines and auxiliary equipment installed on ECC the abovementioned aircraft from time to time, as well as the insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance written consent.
- C 116 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
Fixed and specific first-tier pledge and lien in favor of a trustee for collateral (for ECD). The pledge and lien include all the rights deriving from contracts connected to ECD 2002 the plane, rights to indemnification or insurance proceeds for the aircraft or their 777- ECE 2007 engines, or any part related to it and all rights deriving from the lease agreement for 200ER ECF 2007 the aircraft. In addition, the Company assigned by way of a pledge in favor of a foreign company, all of the existing and/or future rights arising from insurance policies for the aircraft. Fixed and specific first-tier pledge and lien (for ELA and ELB for an overseas banking corporation, for ELC and ELE for an Israeli bank and for ELD for Israeli banks) on all of the Company's rights to the planes. The pledge and lien include all the engines, the ELA 1994 rights deriving from the lease or use of the aircraft or contracts or insurance policies ELB 1994 and rights to indemnification or insurance proceeds for the aircraft in question. In 747-400 ELC 1995 addition, a first-tier floating lien was registered on all the engines and auxiliary ELD 1999 equipment installed on the abovementioned aircraft from time to time, as well as the ELE 1994 insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance, written consent. Fixed and specific first-tier pledge and lien for an Israeli bank on all of the Company's rights to the planes. The pledge and lien include all the engines, the rights deriving EBT 1991 from the lease or use of the aircraft or contracts or insurance policies and rights to 757- EBU 1993 indemnification or insurance proceeds for the aircraft in question. In addition, a first- 200ER EBV 1993 tier floating lien was registered on all the engines and auxiliary equipment installed on the abovementioned aircraft from time to time, as well as the insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance, written consent. Fixed and specific first-tier pledge and lien for an Israeli bank on all of the Company's rights to the planes. The pledge and lien include all the engines, the rights deriving EAC 1984 from the lease or use of the aircraft or contracts or insurance policies and rights to EAD 1984 767- indemnification or insurance proceeds for the aircraft in question. In addition, a first- EAE 1990 200ER tier floating lien was registered on all the engines and auxiliary equipment installed on EAF 1990 the abovementioned aircraft from time to time, as well as the insurance rights with
respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance, written consent. Fixed and specific first-tier pledge and lien for an Israeli bank on all of the Company's EKA rights to the planes. The pledge and lien include all the engines, the rights deriving EKB from the lease or use of the aircraft or contracts or insurance policies and rights to 737-800 EKC 1999 indemnification or insurance proceeds for the aircraft in question. In addition, a first- 737-700 EKD tier floating lien was registered on all the engines and auxiliary equipment installed on EKE the abovementioned aircraft from time to time, as well as the insurance rights with respect to them. No additional lien may be registered on those assets and the assets may not be transferred without the bank’s advance, written consent. Fixed and specific first-tier pledge and lien in favor of a trustee for collateral (see Note 22.d.3) on all of the Company's rights to the planes The pledge and lien include all the EKH rights deriving from contracts connected to the plane, rights to indemnification or EKJ 2009 737-800 insurance proceeds for the aircraft, engines, or any related to it and all rights under EKL from the lease agreement for the aircraft.
In addition, the Company assigned by way of a pledge in favor of a foreign company, all of the existing and/or future rights arising from insurance policies for the aircraft.
Additional liens:
1. In order to secure the Company’s liabilities for the utilization of credit lines provided to it by two banks in Israel (including the furnishing of bank guarantees), the Company pledged its revenues from three specific travel agencies in Israel by way of mortgaging and registering first-tier floating and perpetual liens and by way of assignment of rights in the form of a pledge.
2. A lien in favor of an Israeli bank on funds deposited or to be deposited from time to time, including income thereon, in the Company's accounts in the London branch of said bank.
- C 117 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
3. To guarantee a long term loan received from a leasing company for the purchase of an engine for the 777- 200 fleet, the Company listed a first-tier loan unlimited in sum on the engine (including insurance, compensation and indemnification rights).
4. A lien in favor of a foreign bank on a spare engine for the 777-200 fleet, purchased with the financing of an overseas bank, for which the foreign bank provided collateral. The lien includes rights deriving from insurance, compensation and remuneration.
5. Regarding the leased aircraft in the 737-800 fleet (marked EKS and EKF), liens on all of the insurance policies pertaining to the asset for a foreign company. No additional lien may be registered on those assets and the assets may not be transferred without the owner's consent
Note 42 - Events Subsequent to the Balance Sheet Date
1. In January 2011 civil uprisings began in several North African countries based on the lack of civil rights, the absence of democracy and poor economic conditions with increasing unemployment. As a result of this instability, fuel prices climbed to $91 per barrel in the beginning of January and $101 per barrel immediately prior to the publication of these Financial Statements. The meaning of a 1 cent increase in jet fuel prices for an entire year means an added yearly expense of $2.5 million. The Company has jet fuel hedging transactions (see Note 31g). Following the increase in jet fuel prices the Company decided to update its fuel surcharge starting April 2011. The fair value of the jet fuel hedging transactions immediately prior to the publication of the report is, according to the Company’s estimates, $52.2 million. This value includes transactions for the purchase of financial instruments as described in Section 10 below.
2. On January 19 2011 the Company’s General Meeting ratified the continuation of the tenures of the directors serving on the Company's Board of Directors (who are not external directors) as follows: Amikam Cohen, Tamar Moses Borowich, Yehuda (Yudi) Levi, Professor Israel (Izzy) Borowich, Amonon Lipkin-Shahak, Amiaz Sagis, Nadav Palti, Eran Ilan, Pinchas Ginsburg and Shlomo Hannael as well as the appointment of Ms. Sophia Kimmerling as member of the Company's Board of Directors, until the conclusion of next annual General Meeting.
3. On February 7 2011 an agreement was signed with aircraft manufacturer Boeing (“the Agreement") for the purchase of three new Boeing 737-900 aircraft. For further details, see Note 16.e.1.c.
4. On February 10 2011 the Company’s Board of Directors ratified the signing of a settlement with the Income Tax Authorities. For details see Note 28f.
5. In February 2011 an agreement was signed with R.B. Leasing Company Limited. for the purchase of a 747- 400 passenger aircraft. The aircraft, manufactured in 1996, shall be renovated and adapted to the Company's service, so that includes 387 seats and serves the Company for medium and long-range destinations. The aircraft joined the Company’s aircraft fleet on February 22 2011. The cost of the aircraft is $17.9 million; the investments required for its adaptation to Company service are estimated at $4 million.
6. In February 2011 the Company was provided with a copy of a motion to approve the filing of a claim as a derivative claim, as well as a copy of the derivative claim, regarding the approval of the incentive bonus formula for the Company’s previous CEO. For details see Note 27.c.(c).(9).
7. As special collective agreement pertaining to temporary flight attendants and temporary employees in the administrative sector was signed in February 2011. For details see Note 23.c.(13).
8. On March 10 2011, the Securities Authority provided the Company with an audit regarding the terms of the employment of senior Company executives, including the Company's outgoing CEO, Mr. Chaim Romano. On March 14 2011 the Company announced that pursuant to the talks the Company is conducting to restore and/or receive compensation for an excess of 4 million NIS paid the outgoing CEO, the Company negotiated with the outgoing CEO that he would refund the Company a total of 1 million NIS and the Company also negotiated with the insurance company, with which the Company entered into an executive insurance policy, that it would pay the Company a total of $750 thousand U.S., on account of the compensation required from directors and executives or either to reduce or clear the derivative claim. Note - C 118 - Free Translation of the Hebrew Language 2010 Annual Report - Hebrew Wording Binding
that Professor Israel Borowich resigned from the Company’s Board of Directors on March 9 2011, for further details see Note 38d.
9. On March 20 2011 the Civil Aviation Authority (CAA) informed subsidiary Sun D’Or International Airlines (Sun D’OR) that it would be revoking Sun D’Or's operational license starting April 1 2011. This announcement by the CAA followed talks between the CAA and Sun D’Or and the CAA’s requirements regarding Sun D’Or’s licensing and its operational performance and following a proceeding held before the European Commission on March 16 2011, to which CAA and Sun D’OR representatives were invited in order to provide explanations regarding the structure of Sun D’Or and its operations, in order for the European Commission to decide whether to place operational restrictions on Sun D’Or’s flights to Europe. The Company has no financial estimate regarding the announcement at this stage. The Company is acting along with the CAA in order to formulate an alternative response to Sun D’Or’s flight array, while examining the implications of the license revocation in question.
10. In March 2011 the Company conducted sales and purchase transactions of certain financial instruments pursuant to its jet fuel hedging portfolio for the period between September 2011 and March 2012, mainly consisting of replacing some of the financial instruments used to hedge jet fuel in the period in question with other financial instruments, while making an early realization of hedging revenues to the amount of $31 million and purchasing other financial instruments worth $6 million in such a manner that the total result of the actions in question derived a cash bonus of $25 million that entered the Company's accounts. Hedging revenues to the amount of $31 million shall be recognized in the Company’s Statements of Operations based on the original repayment dates of the transaction for the period in question of which $22 million shall be recognized in the second half of 2011 and the balance to the amount of $9 million shall be recognized in the first quarter of 2012. The sales transactions have no impact past that described above on the Company’s jet fuel hedging for other periods.
11. On March 22 2011 the Company CEO informed the Company Board of Directors, at his own initiative, that he had decided to transfer to the Excellence and People fund, to be established in 2011, a sum equal to 50% of the yearly bonus owed him for 2010, in accordance with the term of his employment, meaning a total of 5.7 million NIS (gross). For details see Note 38f
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