Translation of the Hebrew Language financial statements EL AL ISRAEL AIRLINES LTD. 2006 ANNUAL REPORT MESSAGE FROM THE CEO AND THE CHAIRMAN OF THE BOARD CHAPTER A - OVERVIEW OF THE ENTITY'S BUSINESS CHAPTER B - DIRECTORS' REPORT CHAPTER C - 2006 FINANCIAL STATEMENTS Greetings, El Al's financial results for 2006 emphasize above all the Company's strength and its ability to overcome obstacles, business wise and market wise, even when all external negative variables join forces and create a negative trend. 2006 has presented El Al with numerous challenges which, each on its own, and without doubt all of them combined together, have an intense effect on the Company's operations. Fuel price increased to new historic records during 2006, adding approximately 136.9 million US dollars, excluding hedging activities, to the company's expenses. Hedging activities performed according to Company's hedging policy saved approximately 52.3 million US dollars in fuel costs during 2006. Unprecedented increase in competition and in the overall capacity, was reflected by an increase of 21% in seat supply offered by schedule Airlines (namely, an increase of seat supply by 840 thousand seats), in light of approximately 6% increase in traffic at Ben-Gurion Airport. Regulatory changes led to unprecedented utilization of the "Sixth Freedom" by foreign carriers, which is basically translated to an increase in number of passengers traveling out of Israel via the foreign carrier's hub to any third destination around the world. Weakening of the US currency in relation to other currencies caused an increase in the company's expenses. And above all, the Second Lebanese War, which occurred during the high season led to cancellation of outgoing flights and to a reduction of incoming tourism to Israel. All of the aforementioned was translated to an annual loss of approximately 44.4 million dollars in 2006. Throughout the year, El Al has acted skillfully and proactively to dynamically adjust its economic and commercial policy to the developing and changing environment. We implemented a hedging policy in order to minimize the effects of fuel costs, as well as those of interest rate and currency rate, flight capacity offered by the company was adjusted to cope with competitive conditions and thus was reduced in cases where the actual demand for certain destination was negatively affected by the war, marketing efforts were intensified in order to achieve higher demand around the world and in Israel, and restructuring measures were implemented and accelerated in Israel and abroad in an effort to match the company's fixed costs to the changing competitive and geopolitical reality. Thanks to the strategic decision making and to employees' efforts throughout 2006, and despite the difficult circumstances described herein, El Al's revenues increased by approximately 46 million dollars compared to the previous year, an increase of approximately 3%, totaling approximately 1.7 billion dollars. We succeeded in raising load factor up to 81.3%, reflecting an increase of 2.4% compared to 79.4% last year. This growth is impressive especially in light of the increase in seat available by foreign carriers. These serve as good indicators of the company's strength and its ability to face and overcome challenges. Parallel to the crises and the timely managerial decisions that were taken, we continued, firmly and consistently, to advance the El Al 2010 vision - to lead the Israeli aviation market and to be the first and preferred choice for air traffic to and from Israel. During the year, we invested approximately 70 million US Dollars in equipping and modernizing the company's fleet. We also invested in additional ground equipment and cutting edge IT enhancement. Revenues from cargo transport amounted to approximately 317.6 million US Dollars in 2006, reflecting an increase of about 8% compared to 2005, a good example of company's implementation of a strategic plan to develop additional profit centers. El Al's Operational precision reached 84% during 2006, among the highest in Europe, reflecting an improvement of 5% compared to 2005. The company shows impressively low rate of baggage loss compared to other international Airlines. El Al's website underwent a process of accelerated technological upgrading during 2006 that is continuing at a greater pace in 2007 and has consistently led to an increase in online sales. The services provided by the company's website have been expanded, including online check-in service used by over10% of the passengers. Self checking stands have been set up in the terminal for passengers traveling only with hand baggage. Business sections onboard the 737, 757 and 767 fleets have been rearranged, both by installation of new wider and designed seats with greater inclining to offer a spacious and more comfortable experience. The company launched refurnished business lounge in Paris and added new direct flight destinations, such as Los Angeles and Miami, while extending flight operations to the Far East. The company has adjusted its flight schedule to Europe in order to maximize and optimize convenient connectivity for transit passengers continuing on connection flights and has also developed and improved the product for business travelers to various European destinations. The overall focused attention and addressing to the needs of the business traveler has consistently resulted in growth in El Al's share of the premium traffic from Ben-Gurion Airport, which increased this year by approximately 13% compared to 2005. More than anything, the company's strategic investment in the various service elements has been fruitful, as reflected in passengers' feedback and grading on service parameters, which reached a record high this year compared to the overall grading over the past decade. It is not coincident that El Al was recently chosen, in an annual survey of the newspaper "Yediot Ahronot", as the leading brand name in Israel, as the most outstanding company with regard to quality of service among the airline carriers flying into and out of Israel, and El Al's frequent flyer club was chosen as the best club among Airline companies for international flights flying to and from Israel.* We are obviously, heading towards the summer of 2007, when two new flagship aircraft of the Company are scheduled to arrive in Israel - advanced 777 Aircraft, which offer El Al's customers a quality product aligned with the best standards in the world. We are confident that El Al obtains the ability to confront with the challenges while enhancing sales ability and improving its product in order to cope with constant change in the environment including increased competition, in an endless effort to achieve the vision of providing investors yields and to fly together and elevate towards new heights. We wish to thank all of the company's employees for their devotion and contribution. Prof. Israel (Izzy) Borovich Haim Romano Chairman of the Board Chief Executive Officer * The prize was presented subsequent to the date of signing the financial statements and was not known on that date. Translation of the Hebrew Language financial statements ______________ 2006 ANNUAL REPORT CHAPTER A OVERVIEW OF THE ENTITY'S BUSINESS Translation of the Hebrew Language financial statements TABLE OF CONTENTS Chapter 1: General 3 Chapter 2: Description of the general development of the corporation’s business 4 1. The corporation’s activities and a description of the development of its business 4 1.1 General 4 1.2 Diagram of holdings 5 1.3 Year and form of incorporation 6 1.4 Changes in the corporation’s business 6 2. Operating areas 7 3. Investments in the corporation’s capital 8 3.1 General 8 3.2 Options 9 3.3 Shares held by Company employees 10 3.4 Changes in holdings of interested parties 11 3.5 Table summarizing data on interested party holdings 12 4. Distribution of dividends 14 5. Financial data on the corporation’s operating areas 14 5.1 Nature of consolidation adjustments 16 5.2 Explanation of developments taking place in operating areas 16 6. General environment and effect of external factors with regard to the Company 17 6.1 Traffic in the international aviation Industry 17 6.2 Traffic in the Israeli aviation Industry 18 6.3 Fluctuations in jet fuel prices 18 6.4 Currency rate fluctuations 19 6.5 Interest rate fluctuations 19 Chapter 3: Description of the corporation’s business by operating areas 19 7. Passenger aircraft area 19 7.1 General information on the operating area 19 7.2 Services in the operating area 30 7.3 Analysis of revenues and profitability from services 36 7.4 New services 37 7.5 Customers 37 7.6 Marketing and distribution 37 7.7 Reservations backlog 39 a-1 Translation of the Hebrew Language financial statements 7.8 Competition 40 7.9 Seasonality 41 7.10 Productive capacity 42 7.11aircraft Fleet 44 8. Cargo aircraft area 46 8.1 General information on the operating area 46 8.2 Services in the operating area 51 8.3 Analysis of revenues and profitability from services 53 8.4 New services 53 8.5 Customers, marketing and distribution 54 8.6 Reservations backlog 54 8.7 Competition 54 8.8 Seasonality 58 8.9 Productive capacity 58 8.10aircraft Fleet 59 8.11 Raw materials and suppliers 60 9. Details on the two operating areas 61 9.1 Fixed assets and installations 61 9.2 Insurance 63 9.3 Intangible assets 64 9.4 Human resources 65 9.5 Raw materials and suppliers 79 9.6 Working capital 81 9.7 Investments 82 9.8 Financing 85 9.9 Taxation 88 9.10 Environmental matters 89 9.11 Restrictions and regulation of the corporation’s business 93 9.12 Material agreements 126 9.13 Cooperation agreements 127 9.14 Legal proceedings 127 9.15 Goals and business strategy 134 9.16 Forecasted developments in the coming year 136 9.17 Financial data on geographical segments 137 9.18 Discussion of risk factors 137 a-2 Translation of the Hebrew Language financial statements CHAPTER 1: GENERAL El Al Israel Airlines Ltd.