EL AL ISRAEL AIRLINES LTD.

Transcription

1 Free Translation of the Hebrew Language Financial Report Hebrew Wording Binding EL AL ISRAEL AIRLINES LTD. FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2014 (unaudited( CONTENTS SECTION A UPDATE OF CHAPTER A TO 2013 ANNUAL REPORT SECTION B DIRECTOR'S REPORT SECTION C FINANCIAL STATEMENTS

2 Update to Chapter "A" (Corporate Business Description) 1 Of the Periodic Report for the Year 2013 ("Periodic Report") Of ElAl Israel Airlines Ltd. (hereinafter: "The Company") The following are updates to Chapter A Corporate Business Description: General The Group's concise consolidated financial statements (hereinafter: "Interim Financial Statements") have been prepared in accordance with International Standard IAS 34, "Interim Financial Statements". In the framework of the preparation of these Interim Financial Statements, the Group has applied accounting policy, presentation rules and calculation methods identical to those applied in the preparation of its financial statements as at December 31, 2013, and for the year ending on the same date. Regarding UP flights revenue recognition policy and new accounting standards adopted, see Notes 2 and 3 to the Financial Statements. This update contains material changes or novelties that have occurred to the Company's business during the third quarter of 2014 and that must be described in the Periodic Report. This update refers to section numbers as they appear in the Corporate Business Description Chapter of the Company's Periodic Report for the year 2013, which was published on March 19, 2014 (Reference No ). In reference to Section 6.1 International Aviation Traffic and to Section (A) Changes in the Sector's Volume of Operations and Profitability International Developments IATA data for January to September 2014 indicate an increase of 5.9% in passenger traffic on both international and domestic flights together, with international traffic alone reporting an increase of 6.3% compared to the corresponding period last year. Supply of airline seats on international flights increased at a rate of 6.5%. Rate of occupancy on international passenger flights was 79.9% compared to 80% in the corresponding period last year. 1 The update is in accordance with Section 39A of the Securities (Periodic and Immediate Reports) Regulations, , and contains material changes or novelties which have occurred in the corporate business in any matter that should be described in the Periodic Report. The update refers to section numbers as they appear in the Corporate Business Description Chapter of the Company's Periodic Report for the year 2013, which was published on March 19, A1

3 By Regions: January to September 2014 compared to January September 2013*: *The above table describes international traffic data only. ASK RPK PLF Available Seat Kilometer Available SeatKM: number of seats offered for sale multiplied by the distance flown. Revenue Passenger Kilometer Number of paying passengers multiplied by the distance flown Local Factor Occupancy rate in passenger flights (percentage of seats used). The aviation industry is facing many threats weakness of key economies such as Europe and Brazil, the potential threat of the spread of Ebola which might lead to decrease in demand for flights as well as the political instability in certain areas of the world. Nevertheless, the increase in the number of passengers worldwide and mainly the tendentious weakening of oil prices in recent months, lead to optimistic forecasts. In June 2014, IATA published a profit forecast whereby airlines around the world are expected to present an 18 billion dollar profit in 2014, thus constituting 2.4% of the overall profit turnover, which is expected to amount to 746 billion dollars. In reference to Section 6.2 Israel Aviation Traffic and to Section (B) Changes in the Sector's Volume of Operations and Profitability Developments in the Israeli Market In addition to the effect of "Operation Protective Edge", as specified below, also the shifting of the Jewish Holidays, part of which took place in October (fourth quarter), caused, on the one hand, a decrease in the number of passengers from and to Israel, and on the other hand, resulted in the addition of activity days to the Company, thus contributing to an increase in the Company's market share as specified in Sections and 7.2 below. According to the data provided by the Central Bureau of Statistics, in the third quarter of 2014, about 1.7 million departures of Israelis by air were recorded, without any significant change compared to the corresponding quarter of the previous year. In addition, about 470 thousands of tourist arrivals by air (BenGurion Airport and Eilat) were recorded in the third quarter of 2014 (not including day trips), constituting a decrease of about 25% in relation to the corresponding quarter of A2

4 the previous year. According to the data provided by Israel Airports Authority, a total decrease of about 7% in the international traffic at BenGurion Airport was recorded in this quarter, compared to the corresponding period last year. Supply of seats offered by airlines operating at BenGurion Airport decreased in approximately 1.2% and the average load factor on passenger flights was about 81.5%, compared to 86.5% in the third quarter of In the third quarter of 2014, Cargo traffic has increased at a rate of approximately 8.3% compared to the corresponding quarter of the previous year. Operation Protective Edge Following Operation Protective Edge, which started at the beginning of July 2014 and lasted 50 days (until the end of August), a large number of flight cancellations by Israeli and foreign passengers was recorded, both in departing and arriving flights, in addition to a significant decrease in the number of bookings for the Company's flights, which, according to the best understanding of the Company, may be ascribed to Operation Protective Edge. Furthermore, during Operation Protective Edge, the Company suffered additional expenses due to activity adjustment and capacity supplement as well as additional operating expenses resulting from the security situation. On July 22, 2014, the U.S, Federal Aviation Authority (FAA) announced the suspension of flights to and from Israel for 24 hours, which was extended for another 24 hours. As a result, most of the European airlines have also cancelled their flights to Israel. On July 24, 2014, the restriction on flights was removed and gradually, the American airlines announced the renewal of their flights to Israel, and were gradually followed by the European airlines. Even before the wave of flight cancellations on the part of foreign airlines, the Company operated its aircraft fleet at high utilization during the peak of the tourist season. When the foreign airlines halted their flights, the Company made supplements and adjustments to its flights schedule by adding about 16 flights and transferring 20 flights to aircraft with a larger capacity in order to provide maximum response to passengers of foreign airlines whose flights were cancelled. In addition, at the request of the Ministry of Transport, the Company added 9 special flights (and expanded two other flights) in order to rescue passengers whose flights were cancelled by Turkish airlines. Additionally, during Operation Protective Edge, three airlines operating cargo flights to Israel have ceased their flights to Israel for a longer period throughout the third quarter of 2014 (Royal Jordanian for about a week, Korean Air for two months, and Turkish Airlines for about a month). In August 2014 the Company, together with IsraAir and Arkia, applied to government ministries with an urgent request to assist the Israeli airlines and compensate them for the damages and expenses incurred by them, in order to enable them to cope with the crisis in the aviation and tourism industries which resulted from the security situation. As a response, the General Manager of the Ministry of Transport and Road Safety announced the establishment of an interministerial team headed by the General Manager of the Ministry of Tourism, with the participation of the relevant government ministries (including the Ministry of Transport and Road Safety), for the purpose of forming a proposal for possible compensation to the airlines and the entire tourism industry. On September 23, 2014, the Government passed a decision regarding assistance to the tourism industry following Operation Protective Edge, which did not include assistance to the aviation industry. As a result of the airlines' protest over the absence of Government assistance to the airlines, it was resolved to establish an interministerial team headed by the General Manager of the Ministry of Transport and Road Safety, for the purpose of examining the claims of the airlines in A3

5 respect of the economic damages incurred by them due to Operation Protective Edge. On October 22, 2014, the Company presented its stance before the Committee. Recently, Israel Civil Aviation Authority ("CAAI") invited the Israeli airlines to discuss the provision of compensation to the Israeli airlines in respect of Operation Protective Edge. In Reference to Section 6.3 Fluctuations in Jet Fuel Prices and to Section Raw Materials and Suppliers Fuel In the third quarter of 2013, the Company's average jet fuel price (before hedging) dropped in 3.4% compared to the corresponding quarter of the previous year. The Company's average effective jet fuel price, after hedging, increased by approximately 4.5% compared to the corresponding quarter of the previous year. In the third quarter of 2014, fuel expenses constituted about 34.1% of the turnover (whereas in the corresponding quarter of the previous year, fuel expenses constituted about 30.3% of the turnover). As at September 30, 2014, the Company held jet fuel inventory which was purchased from suppliers in Israel and abroad, totaling approximately 8.3 billion dollars. For further details, see Section B1 (3) of the Directors Report on the State of the Company's Affairs as at September 30, In Reference to Section 6.4 Fluctuations in Foreign Currency Rates As at September 30, 2014, a decrease of about 4.5% occurred in the exchange rate of NIS against the US dollar compared to September 30, 2013, and a decrease of about 6.5% compared to December 31, As at September 30, 2014, an increase of about 7.3% occurred in the exchange rate of the US dollar against the Euro compared to September 30, 2013, and an increase of about 9.5% compared to December 31, For further details, see Section B1 (5) of the Directors Report on the State of the Company's Affairs as at September 30, In Reference to Section 6.5 Interest Rate Fluctuations The average 3month Libor interest rate dropped in the third quarter of 2014 from 0.26% to 0.23% compared to the corresponding quarter of the previous year. For further details, see Section B1 (4) of the Directors Report on the State of the Company's Affairs as at September 30, Passenger Aircraft Operations In Reference to Section Changes in the Sector's Volume of Operations and Profitability In June 2014, IATA published a new profit forecast for the year 2014, whereby airlines worldwide are expected to present an 18 billion dollar profit (compared to 18.7 billion dollar profit according to the March 2014 forecast), constituting about 2.4% of the profit all airlines, which is expected to reach 746 billion dollars. The data contained in the following table refers to the overall operations of the airlines on both international and domestic flights together, by region: A4

6 The main causes for the change in IATA's 2014 forecast are set forth below: GDP Global growth rate in 2014 is expected to reach approximately 2.8%, higher than the growth rate in 2013, which amounted to approximately 2.4%. Passengers passenger traffic is expected to increase by 5.9%, the highest growth rate since 2011 and higher than the 5.5% trend registered during the last 20 years. Passenger traffic accelerates due to the expected GDP growth and due to the fact that passengers enjoy cheap flights at an average price of 231 dollars per flightsection in 2014 (without additional charges and taxes), constituting a drop of about 4% in air cargo transportation prices. Fuel prices fuel prices are stable and the total fuel costs of airline companies are expected to reach about 212 billion dollars, constituting about 30% of their total operation costs. Therefore, jet fuel prices remain without significant change and are expected to reach an average of dollar per barrel in 2014 (compared to dollar per barrel in 2013). In Reference to Section Technological Changes that may Materially Affect the Field of Operations In the third quarter of 2014, online sales through the Company's website (including flight tickets, upgrades and sales of related products) increased by 30% compared to the corresponding period last year. This growth is the result of improving sales capabilities, enriching the variety of the Company's products offered on the website, maintaining the development of the UPbrand website as well as the result of selling UPbrand flight tickets. In Reference to Section Structure of Competition in the Field of Operations and Changes occurring thereto; Developments in Markets related to the Field of Operations In the third quarter of 2014, a decrease of about 8% was recorded in the passenger traffic of foreign scheduled airlines operating on routes to and from Israel and a decrease of about 23% in charter companies operations. Overall, charter flight traffic was about 19% of the total traffic at Ben Gurion Airport, compared to 22% in the corresponding quarter of the previous year. The Company's passenger traffic on international flights (including passengers of flights marketed by Sundor) increased by approximately 4% and the Company's share in the overall passenger traffic in the third quarter of 2014 was 33.8% compared to 30.2% in the third quarter of In total, international passenger traffic at BenGurion Airport dropped in the third quarter of 2015 by about 7%. As stated, following Operation Protective Edge, many flight cancellations were recorded, either by Israeli or foreign passengers. Due to the decrease in demand, some airline companies reduced the A5

7 volume of their operations on routes to and from Israel and flights of international airlines were completely cancelled for 48 hours following the instruction of the U.S. Federal Aviation Authority ("FAA") regarding suspension of U.S. airlines' flights, as specified in Section 6.2 above. In view of the above, most airline companies operating flights on routes to and from Israel have registered a decrease in passenger traffic. However, notwithstanding the foregoing, passenger traffic in most foreign lowcost airlines continued to grow, as a result of deepening their activity on routes to Israel, both by adding flights and by expanding their destinations, as set forth below: WizzAir, the Hungarian lowcost airline which, in the corresponding quarter of the previous year, operated flights on routes to Budapest (7 weekly flights) and Bucharest (3 weekly flights) only, has expanded its activity during the year, and in the third quarter of 2014 operated flights from 8 different destinations (Budapest, Bucharest, Katowice, Warsaw, Prague, Vilnius, ClujNapoca and Sofia). Despite the reduction in the frequency of flights on routes to Budapest and Bucharest as a result of Operation Protective Edge, and in spite of the cancellation of all flights to Katowice, Warsaw and Prague since September 2014, WizzAir recorded a passenger traffic increase of 111% in the third quarter of It shall be noted that starting from November 2014, WizzAir began to gradually renew its flights to Israel. Easy Jet, the British airline company, operated 33 weekly flights this quarter to destinations between Israel and Europe Lawton (11), London Gatwick (3), Manchester (2), Bazel (4), Geneva (5), Rome (2), Milano (3) and Berlin (3), compared to 19 weekly flights from four destinations only in the third quarter of In total, Easy Jet recorded a passenger traffic increase of 57%; Pegasus, the Turkish lowcost airline, added a third daily flight on the route between TelAviv and Istanbul (from 14 to 21 weekly flights, and despite cancellation of some of its flights, recorded a passenger traffic increase of 14%; Norwegian Air Shuttle added a third flight on routes between TelAviv and Stockholm and started operating weekly flights on the route between TelAviv and Liege, and has thus doubled its passenger traffic; Jetair Fly, the Belgic airline that operated this quarter three weekly flights on the route to Brussels instead of two weekly flights on the route between TelAviv and Liege, recorded a passenger traffic increase of 25%, and Vueling, the Spanish company that operated a daily flight (7 frequencies) on the route to Barcelona instead of five and recorded a passenger traffic increase of 12%. In addition, also Transavia, a company owned by Air France KLM Group, started to operate one weekly flight on the route to Lyon. The share of the foreign lowcost airlines (not including the Company's UP flights) in the total traffic at BenGurion Airport in the third quarter reached approximately 11% compared to only 8% in the third quarter of The Company estimates that the trend of the increased competition is expected to continue, due to the return of airline companies to ordinary activity after the end of Operation Protective Edge as well as in view of the expansion of the activity and the expected growth in the frequency of flights operated by a number of airlines upon the beginning of the 2014/2015 Winter Season Schedule. The following are some outstanding examples: British Airways is expected to gradually increase the number of its flights to and from London, given that in October 2014 it started to operate 17 weekly flights on this route, that from December 15 it is expected to operate 19 weekly flights and that from March 2015, upon the beginning of the 2015 Summer Schedule, it is expected to increase the number of flights to 20 frequencies on the this route. Russia Airlines started to operate a second daily flight from TelAviv to St. Petersburg. A6

8 Ethiopian Airlines, the Ethiopian airline company that so far has operated 5 weekly flights on the route between Addis Ababa and TelAviv, added 7 weekly flights since the beginning of the Winter Schedule at the end of May 2014, and from December 15 it is expected to increase the number of flights to 14 the Full quota of flights permitted under the Aviation Agreement recently executed by the Ethiopian and Israeli aviation authorities, which allows one airline from each country to operate up to 14 weekly flights. Lufthansa continues to expand its operations in Israel and is expected to add three weekly flights between Frankfurt and TelAviv starting from the Summer Season which commences on March 29, The new flights will be added to 17 weekly flights on routes between Frankfurt and TelAviv and eight weekly flights on routes between Munich and TelAviv, thus in total, the German airline is expected to operate 28 weekly flights to both airports. Alitalia is expected to add three weekly flights on routes between TelAviv and Rome, thus the number of flights operated by Alitalia shall increase to 29 (instead of 26). Brussels Airlines, the Belgian company, is expected to operate 14 weekly flights starting from the 2015 Summer Season Schedule, compared to 11 flights in the corresponding period of the previous year. Further growth is expected in the operations of low cost airline companies upon the arrival of new airlines and the expansion of existing ones. The following are some outstanding examples: Lufthansa Group made changes to the Berlin TelAviv route, so that German Wings (Lufthansa's subsidiary) replaced Lufthansa and operates lowcost flights between TelAviv and Berlin. Air Berlin added to the 2014/15 Winter Schedule two weekly flights on the Berlin route and two weekly flights on the Dusseldorf route, and is expected to operate during Winter Season a total of: 4 weekly flights to Dusseldorf, 2 weekly flights to Munich and 7 flights to Berlin. In the Summer Season the Company shall add extra weekly frequency on the route to Munich (three weekly flights to Munich). The German company German Airlines is expected to start operations in Israel as a regular airline and operate direct flights to Hamburg and BadenBaden (the Black Forest), starting from March The Spanish airline Air Europa is expected to start operating scheduled weekly flights on the route between TelAviv and Madrid. So far, Air Europa has operated charter flights between TelAviv and Barcelona, as well as flights to Palma DeMallorca during the Summer Season; from time to time it operates charter flights to Madrid. Transavia, a company under the joint ownership of Air France and KLM, is expected to operate, starting from April 2015, three scheduled weekly flights on the route between TelAviv and Amsterdam, in addition to flights it has started to operate from Paris and Lyon. The Turkish lowcost airline, Pegasus Airlines, is expected to operate a daily flight on the route between Antalya and TelAviv, starting from next spring. In Reference to Section 7.2 Services in the Field of Operations The following are data regarding the development of passenger traffic by main destination groups: In the third quarter of 2014, international passenger traffic at BenGurion Airport decreased at a rate of about 7% compared to the third quarter of Passenger traffic in the third quarter of 2014 A7

9 was divided between the following airlines: ElAl (including flights marketer by Sundor) 33.8%; other regular airlines 49.8%; charter airlines 16.4%. The Routes to Europe Passenger traffic on routes to Europe (West Europe, Commonwealth countries and East Europe) decreased by about 5% in the third quarter of 2014 compared to the corresponding quarter of the previous year. Foreign regular airlines that operated in this network of routes have recorded a decrease of about 6% in passenger traffic, whereas charter airlines operating in this network of routes have recorded a decrease of about 28% compared to the corresponding quarter of the previous year. The Company's passenger traffic on all routes to Europe (including flights marketed by Sundor) increased by about 4% compared to the corresponding quarter of the previous year. Notwithstanding the above, passenger traffic to countries in West and East Europe increased by about 9% compared to the corresponding quarter of the previous year, in light of a significant increase in lowcost activity in those countries, both by the Company, which started operating the UPbrand flights to Budapest, Kiev and Prague and doubled the number of passengers on these routes (+93% and +112%, respectively), and by WizzAir, which expanded its activity during the year and started operating flights from other destinations (ClujNapoca, Katowice, Prague, Sofia and Warsaw). Transatlantic Routes A decrease of about 7% in passenger traffic on routes to North America was recorded in the third quarter of 2014 in relation to the corresponding quarter of the previous year. Foreign regular airlines operating direct flights on these routes recorded a decrease of about 9%, whereas the Company recorded a decrease of about 4% in its passenger traffic. Far East Routes Total passenger traffic on all Far East routes (direct flights) decreased by about 8%. In July 2014, following Operation Protective Edge, Korean Airline has suspended its flights on the route to Seoul, and renewed them only in September As a result, Korean Airline recorded a sharp decrease of about 65% in its passenger traffic in this quarter. No significant change occurred in the Company's passenger traffic in this network of routes. Regional Network In the third quarter of 2014, a significant decrease of about 14% occurred in all passenger traffic on this network of routes compared to the corresponding quarter of the previous year. A decrease of 24% in passenger traffic to Turkey was recorded as a result of the tension between Israel and Turkey following Operation Protective Edge, which led many passengers to choose alternative destinations in the Greek Islands and Cyprus. Turkish Airlines, the national Turkish airline company, announced the cancellation of two daily flights between TelAviv and Istanbul, starting from August 2014; also Pegasus, which operates lowcost scheduled flights on the route to Istanbul and charter flights to Antalya, has cancelled flights. A decline of 9% in passenger traffic on routes to Greece was recorded. On the other hand, a significant increase (+28%) was recorded in the traffic to Cyprus, in view of the Company's operations on this route. In this regard, it should be noted that the Company started operating flights A8

10 on the route to Larnaca in November 2013, and from April 2013 the Company's flights on this route are operated under the UPbrand. In the third quarter of 2014, the Company operated flights in this network of routes only to Greece and Cyprus, and the Company's share of passenger traffic on these routes amounted to 13.2% compared to 9% in the corresponding quarter of the previous year. In Reference to Section 7.4 New Services The Company continues to absorb new ER aircraft. The fourth aircraft (out of eight aircraft purchased by the Company) joined the fleet in July 2014, and the fifth aircraft is expected to join the fleet in March Three additional aircraft are expected to be delivered to the Company by the end of March The advanced aircraft include Business Class with 16 seats offering maximum comfort. New technology manufactured thin seats were installed in Economy Class. Electrical outlets for laptops and UPS connections were installed in the airplanes. New Route to Boston On November 17, 2014, the Company's Board of Directors approved the opening of a new route to Boston. The new route will be launched in June The Company is expected to operate three weekly direct flights using a Boeing aircraft. Boston will be the Company's third direct destination in the U.S. after New York and Los Angeles. Code Share Agreements The Company signed a Code Share Agreement with the U.S. airline JetBlue. The new agreement enables the Company's passengers to purchase a combined flight ticket, under the Company's code, with maximum comfort and flexibility, with respect to connection flights via JFK and Newark airports (New York), to 38 of JetBlue's destination around the U.S. Such flights shall be available for purchase starting from November 2014, and in addition, the Company's customers may also benefit from accumulating Frequent Flyer Club points. Following the merger between American Airlines and U.S. Airways, the terms of cooperation between the Company and American Airlines under the Code Share Agreement were changed, thus the Company's ability to sell connection flights within the United States under the Code Share Agreement was revoked, and starting from November 2014, the Agreement applies only to flights via joint destinations in Europe (destinations in Europe to which both companies fly). At this stage, solely the Company's code share flights via American Airlines can be ticketed, and later on, American Airlines will also be able to sell code share flights via the Company's flights between Europe and Israel. The Company announced the termination of the Time Share Agreement with Vietnam Airlines, starting from October 25, 2014, as a result of changes in aviation agreements between China and Vietnam, which prevent the Company from flying passengers on the routes between Tel Aviv and Hanoi and between TelAviv and Saigon via Hong Kong with El Al code share. A9

11 In Reference to Section Frequent Flyer Program Further to the Company's immediate report dated September 2, 2014 (reference no ), and the execution of an agreement for the issue of branded credit cards to the Company's Frequent Flyer Club members ("the Club") in cooperation with financial institutions, new credit cards branded Fly Card and Fly Card Premium were launched. The Company expect that 300 thousand credit cards will be issued and that a gradual growth will occur in the number of Club members in the coming years to about 1.8 million members. The information regarding the quantity of credit cards to be issued and the growth in the number of Club members is a forwardlooking information, as defined in the Securities Law, , based on the Company's estimates and taking into consideration trends and developments in the consumption and aviation world. The realization of said information, in whole or in part, is not certain and might be affected by factors affecting the competitive environment of the Company and/or factors that cannot be estimated and are not under the Company's control, including factors in the credit cards retail and consumption world. In Reference to Section 7.10 Production Capacity In the third quarter of 2014, the Company's seats supply (in ASK terms) increased by about 5.2% and the number of the Company's paying passengers, multiplied by the distance flown (RPK Revenue Passenger Kilometer), increased by 1.9% compared to the corresponding quarter of the previous year. Therefore, the weighted occupancy rate, which was 84.8% in the corresponding quarter of the previous year, declined to 82.1%. In Reference to Section 7.11 Aircraft Fleet In November 2014, the Company completed a transaction to purchase a Boeing aircraft (EAP) from a foreign company. Prior to the sale, the aircraft was operated by the Company for eight years as a leased aircraft. For details, see Note 6A (4) to the Financial Statement as at September 30, Cargo Aircraft Field of Operations In Reference to Section Structure of Field of Operations and Changes Occurring therein In the third quarter of 2014 the Company's share of the cargo transport market, using the cargo aircraft alone, was 25.1% compared to 24.9% in the corresponding period of the previous year. The Company estimates that its share of cargo transport for the period between July and September 2014 out of all cargo shipped to and from Israel (including cargo carried in the holds of passenger aircraft), including mail activity but excluding Sixth Freedom), was about 35.3%, compared to about 35.9% in the corresponding period last year. In Reference to Section (A) Volume of Global Cargo Transport According to IATA reports, in the months between January and September 2014, an increase of about 4.6% occurred in the volume of global cargo transport (including cargo carried in the holds of passenger aircraft) in relation to the corresponding period last year, thus exceeding the annual rate expected according to IATA estimates (+2.6%). A10

12 In Reference to Section (B) Volume of Cargo Transport by Aircraft to and from Israel According to data provided by Israel Airports Authority, in the months between January and September 2014, the volume of cargo traffic at BenGurion Airport increased by about 3.6% compared to the corresponding period last year. In Reference to Section Technological Changes Champ System in September 2014, the cargo controllers of Ground Operations Division started using a new system for planning of cargo aircraft loading, manufactured by Champ Cargo Systems from Luxembourg. The system is operated using cloud architecture, it calculates the aircraft weight and balance as well as aircraft loads, taking into account the cargo loaded thereon and the restrictions determined by the aircraft manufacturer, and it issues computerized weight and balance forms. The system makes it unnecessary to transfer information manually and improves the reliability of the information. Currently, the first stage of CRM to the Cargo Division in connection with cargo customer management and customer inquiries in Israel is being implemented. This solution replaces manual work, without a system and a structured and transparent documentation for all those who come into contact with customers. This solution is the beginning of an overall management of cargo agents in the fields of service, sale and marketing in Israel and abroad, and provides a comprehensive and integrated picture of the customer with respect to its cargo and passengers activity. Such customer picture shall assist in improving decisionmaking, sales and service. 3. Details on Both Fields of Operations In Reference to Section Organizational Structure In October 2014, Mr. Shelly Zehavi terminated his role as Vice President Cargo Division (and started to serve as the Company's Vice President Commercial and Aviation Ties), in his place, Mr. Ronen Shapira was appointed as Director EL AL Cargo. In Reference to Section Employees Pursuant to Section of Chapter A of the Company s 2013 Periodic Report, the following is an updated table of the Company's employees as of September 30, 2014: September 30, 2014 December 31, 2013 September 30, 2013 Permanent employees 3,772 3,757 3,786 Temporary employees 2,228 1,992 2,097 Total employees 6,000 5,749 5,883 In Reference to Section Office Holders and Senior Management Employees On November 12, 2014, a Shareholders' Special Annual General Meeting took place, in which the following resolutions were passed: 1. To reappoint Brightman Almagor Zohar & Co. as the Company's auditors; A11

13 2. To approve the reappointment of the directors serving on the Company's Board of Directors (except for outside directors): Messrs. Amikam Cohen, Tamar MozesBorovitz, Yehuda (YUDI) Levy, Pinchas Ginsburg, Shlomo Hanael, Shofia Kimerling and Ruth Dahan (Portnoy), until the end of the next annual meeting; 3. To approve the reappointment of Prof. Joshua (Shuki) Shemer for another (third) 3year term of service, starting from November 19, 2014; 4. To approve entering into a framework transaction with Knafaim for the purchase of directors' and officers' group liability insurance together with Knafaim, for a 3year period; 5. To approve revised terms of employment of Nimrod Borovitz, CPA, upon his appointment as Head of Division of Business Development, LongTerm Planning and Equipping; 6. To approve extension of indemnification letters to directors who are controlling shareholders. For details on the service of the outside director, Yair Rabinowitch, CPA, see Note 13B to the financial Statements as at September 30, In Reference to Section 9.8 Financing Further to the Company's reports regarding the Loan Agreement executed in August 2012 with a fully owned subsidiary of the aircraft manufacturer Boeing (BCC), and to the consent of the parties to extend the date for signing an agreement for the lease of two 787 aircraft, or alternatively, an agreement for the purchase of one or more 787 or 777 aircraft until December 15, 2014 the Company is pleased to update that in November 2014, the parties agreed to extend the date until March 31, 2015 or a later date as shall be agreed by the parties. For further details regarding the loan, see Noted 8 and 13C to the Financial Statements as at September 20, For details regarding the financing of advances in respect of the two aircraft, see Note 8 to the Financial Statements. In Reference to Section Restrictions in the Operation of Aircraft at Airports and at BenGurion Airport Further to the Company's update in its Financial Statements as at December 31, 2014, regarding the decision of the Minister of Transport dated January 12, 2014, to change the hours that BenGurion Airport is closed for takeoffs ("Night Curfew"), the Municipality of the City of Holon Head of the Forum of Authorities Surrounding Ben Gurion Airport against the Minister of Transport and Road Safety and the CAAI filed a petition to the Court of Administrative Affairs of the Central District, claiming that the Minister of Transport was wrong in exercising his discretion and that he must order the extension of Night Curfew hours, beyond those determined in his decision. The Company joined as a respondent to the petition, together with other airlines and IATA. The parties to the petition have reached a compromise agreement that was approved by the court on November 6, According to the compromise agreement, the time of the beginning of the Night Curfew shall not be changed in relation to the time set in the decision of the Minister of Transport so that throughout the whole year takeoffs will be fully permitted until 01:40. From 01:40 to 02:0 three takeoffs will be allowed, as stated in the CAAI decisions dated January 26, A12

14 During the Winter Season (as defined by IATA) the end of the Night Curfew will be extended from 05:20 to 05:30. Accordingly, the half hour in which only takeoffs of aircraft that do not deviate from Reduced Noise Threshold (as defined in the Minister's decision) are allowed will end at 06:00. During the Summer Season (as defined by IATA) the end of the Night Curfew will be extended from 04:50 to 05:00. In addition, the half hour in which only takeoffs of aircraft that do not deviate from Reduced Noise Threshold are allowed will be extended by one hour and end at 06:00. Similar to the Minister's decision, the arrangement also provides that aircraft that did not manage to takeoff at night (before Night Curfew), including aircraft that do not comply with Reduced Noise Threshold, may takeoff once the airport is open for takeoffs, if the Manager of BenGurion Airport so permits. In Reference to Section Regulatory Arrangements Pursuant to the decision of the International Civil Aviation Organization ("IOCA"), on December 13, 2014, the ICAO's decision whereby pilots beyond the age of 65 are no longer permitted to fly commercial aircraft, entered into effect. Following the IOCA decision, on August 13, 2014, the CAAI decided that starting from the date of entry into effect of the of the IOCA's decision, all personal exemptions granted by the CAAI to the Company's pilots (allowing them, despite the provisions of the Flight Regulations, to fly beyond the age of 65 as copilots) shall be cancelled, and that the Manager of the Airports Authority will no longer provide exemptions from the provisions of the Flight Regulations to pilots approaching the age of 65. Following the said decision, the Israel Air Line Pilots Association filed a petition to the Court of Administrative Affairs of the Central District, against the CAAI's decision. On November 13, 2014, the Court rejected the petition, to the extent it concerns the CAAI's decision whereby starting from the date of entry into effect of the binding international standard all personal exemptions granted as aforesaid will be cancelled, but accepted the petition regarding the ICCA's decision to cancel personal exemptions that were already granted and the declaration to avoid granting exemptions. On November 17, 2014, a motion was filed by the Company to the Regional Labor Court of Tel Aviv, in view of difficulties in finding pilots to staff flights, which resulted from lack of responsiveness of the Company's pilots to the Company's requests. The Court resolved that the Company's workers' Union and the Histadrut shall refrain from any organizational or other action that may interrupt the Company's proper course of work. In addition, the Workers Union filed a singleparty application in a collective dispute, to obtain reliefs that will require the Company to act so that pilots beyond the age of 65 will have their employment permits back from the CAAI and to refrain from changing the terms of their employment. In the coming weeks, a legal hearing is expected to take place at the Labor Court on this matter. In Reference to Section Security Arrangements Aircraft Protection Systems Further to the Company's update in its Financial Statement as at December 31, 2013, on the issue of aircraft protection systems, on September 30, 2014, agreements were executed between ElAl and the State of Israel, and between ElAl and Elbit Systems Electrooptics Elop Ltd., as regards the installation of the protection systems in ElAl airplanes and in Arkia airplanes. A13

15 In Reference to Section 9.12 Material Agreements On August 24, 2014, an agreement was executed with the Government ministries for the years As done since 2006, the Company and the Government ministries tend to enter into an agreement for discounts, benefits and returns in purchasing flight services for State employees and representatives. In the third quarter of 2014, the implementation of the new dutyfree agreement with DFASS DISTRIBUTION LLC, which includes, inter alia, a new purchase agreement of dutyfree items, equipment with new computerized systems, including new website and provision of commercial consulting. A14

16 EL AL ISRAEL LINES LIMITED BOARD OF DIRECTORS REPORT ON THE STATE OF THE CORPORATION'S BUSINESS FOR THE PERIOD ENDED SEPTEMBER 30, 2014 The Company and its business environment We are pleased to present the Board of Directors Report on the state of the Corporation's business for the period of nine months ended September 30, The Company serves as the designated air carrier of the State of Israel in most international routes operating to and from Israel. The key activities of the Company and its subsidiaries in carrying passengers and cargo, on scheduled flights, and charter flights, between Israel and foreign countries and during the period from August 2010 until the end of 2013, also on internal flights. In addition, the Company is engaged in providing security services and current maintenance services and overall maintenance for aircraft of other companies at the Ben Gurion Airport, the sale of duty free products, the leasing of aircraft and, through investee companies related activities, mainly the production and supply of food for its flights and managing a number of travel agencies abroad. The business environment in which the Company operates is the civil and international aviation industry and tourism to and from Israel, which is characterized by seasonality and a high level of competition, and which is more difficult during periods of excess capacity, as well as being highly sensitive to the economic, political and security situation in Israel and globally. The Group has two fields of activity, which are reported as operating segments in its consolidated financial statements: a) The operations of passenger aircraft In this segment the Company carries passengers in passenger aircraft, as well as cargo, which is carried in the holds of these aircraft, and provides auxiliary services, such as: the sale of duty free products. In the field of passenger transport, the Company competes in flights to and from Israel with two Israeli companies (Arkia and Israir) and over 60 foreign airline companies that operate scheduled flights and over 50 foreign charter companies. Revenues in this field of operations comprised 92.0% of all the Company's revenues in the third quarter of b) Cargo aircraft activities in this segment the Company transports cargo in one leased cargo aircraft. In cargo transporting the Company competes with an Israeli airline (CAL) and seven foreign airlines, which operate continuous cargo aircraft, and with most of the scheduled airline companies which operate passenger aircraft and transport cargo in their holds. Revenues in this segment of operations comprised 2.7% of total Company revenues during the third quarter or The Company has additional revenues, which do not belong to the main segments of activity, comprising 5.3% of total revenues. For additional details regarding the Company's operating segments, see Section a4 below. b1

17 A. EXPLANATIONS OF THE BOARD OF DIRECTORS ON THE STATE OF THE CORPORATION'S BUSINESS A.1 Analysis of the Company's business operations results A 1.1. Market data Passenger and cargo traffic at Ben Gurion Airport Incoming tourists * Departing Israelis * Cargo import tons ** Cargo export tons ** July September Thousands ,693 1, Change Thousands % (153) (25%) (4) (0%) 1.6 5% % * Source: Central Bureau of Statistics ** Not including cargo in transit Incoming tourist traffic to Israel and departing residents, in the third quarter (in thousands): 1, , , , , ,000 1,750 1,500 1,250 1, Incoming tourists Departing Israelis * Source: Central Bureau of Statistics b2

18 Imports and exports of cargo by air to and from Israel, in the third quarter (in thousands of tons): Export Import * Source: Central Bureau of Statistics Total traffic at Ben Gurion Airport and El Al and Sun Dor's market share in the third quarter total traffic (mill. per passeng. Leg) El Al & Sun D'or share in total traffic (%) % % % 34.7% 34.0% % 31.9% % % % 30% 20% % % Passenger and cargo traffic at Ben Gurion Airport Incoming tourists * Departing Israelis * Cargo import tons ** Cargo export tons ** Jan September Thousands 1,918 1,853 3,686 3, Change Thousands % 4% 7% 5% 2% * Source: Central Bureau of Statistics ** Not including cargo in transit b3

19 A 1.2 The Company's operative data* Passenger leg (scheduled and chartered) in thousands RPK (scheduled) in millions ASK (scheduled) in millions Load factor (scheduled) The Company's market share (scheduled and chartered) Flown cargo, in thousand tons Revenue tons kilometers (RTK) in millions Weighted flying hours (including leased equipment) in thousands ** July September 1,407 1,409 5,453 5,353 6,638 6, % 84.8% 33.8% 30.2% Change (0.1%) 1.9% 5.2% (3.2%) 11.6% 3.9% 9.8% 0.4% * Operating data relates to both international and domestic operations. ** Weighted flying hours in Boeing 767 terms. Operative indices in the third quarter (in millions) 7,000 6,000 5,000 4,000 4,947 5,907 6,185 6,028 5,098 5,094 6,309 6,638 5,353 5, % 90% 3,000 2, % 82.4% 84.5% 84.8% 82.1% 80% 1,000 0 RPK ASK L. F. 70% b4

20 Passenger leg (scheduled and chartered) in thousands RPK (scheduled) in millions ASK (scheduled) in millions Load factor (scheduled) The Company's market share (scheduled and chartered) Flown cargo, in thousand tons Revenue tons kilometers (RTK) in millions Weighted flying hours (inc. leased equipment) in thousands ** Aircraft in operation end of period number of units Average age of owned fleet at the end of the period in years Jan September 3,520 3,442 14,474 13,809 17,536 16, % 83.2% 32.8% 32.4% Change 2.3% 4.8% 5.6% (0.7%) 1.1% (1.5%) 1.9% 1.5% 3 (1.2) ** Weighted flying hours in Boeing 767 terms. Operative indices in the first half of the year (in millions) 19,000 17,000 15,000 13,000 17,536 16,044 16,575 16,606 16,067 14,474 13,809 13,120 13,315 13, % 90% 11,000 9,000 7, % 80.3% 82.8% 83.2% 82.5% 80% 5,000 RPK ASK L. F. 70% Glossary: Passenger leg RPK Revenue Passenger Kilometer ASK Available Seat Kilometer RTK Revenue Ton Kilometer Flight coupons for one direction Number of paying passengers multiplied by distance flown. Number of seats offered for sale multiplied by distance flown. Weight of paid flown cargo multiplied by distance flown. Passenger Load Factor (Passenger occupancy) Passenger kilometers flown expressed as a percentage of seatskilometers. Weighted values of aircraft: Boeing 767 = 1.0; Boeing 747 = 2.0; Boeing 777 =1.6; Boeing 737 = 0.6. These weighted averages were determined based on an estimate of the total expenses of every type of aircraft and are consistently used calculating weighted flight hours as an indicator of the level of the aviation activities. b5

21 A2. Statement of income data for (consolidated financial statements) For the period of three months ended September 30: Change $ thousands % turnover $ thousands % turnover $ thousands % Operating revenues 601, % 643, % (42,061) (6.5%) Operating expenses (492,978) (82.0%) (483,550) (75.2%) (9,428) (1.9%) Gross profit 108, % 159, % (51,489) (32.2%) Selling expenses (52,980) (8.8%) (56,416) (8.8%) 3, % General and administrative expenses (26,593) (4.4%) 27,863 (4.3%) 1, % Other income, net % % % Operating profit 29, % 75, % (46,524) (61.5%) Financing expenses (15,539) (4,939) (10,600) Financing income ,110 (10,005) Company's share of the profits of affiliated companies. net of tax 387 (20) 407 Profit before taxes on income 14,018 80,740 (66,722) Taxes on income (3,875) (22,880) 19,005 Profit for the period 10,143 57,860 (47,717) The main factors affecting the business results for the period of three months ended September 30, 2014, compared to the equivalent period in the previous year are: The results of the third quarter were seriously affected by the consequences of the Protective Edge Operation which continued for a period of 50 days in July and August and significantly harmed incoming tourist traffic (decline of 25% compared to the equivalent period in the previous year), and which also affected the decline in yields per passenger kilometer. During the period of the Campaign the company bore extra expenses for adapting its operations in the additional capacity and the additional operating expenses resulting from the security situation. Operating revenues Revenues from operations decreased from during the period of report by 6.5% compared to the equivalent period in the previous year. Revenues from passengers decreased by 7.3%, mainly as a result of a decline in the yield per passenger kilometer as a result of the Protective Edge Operation, as explained above, and the continuing competition due to implementing the "Open Skies" policy. Revenues from cargo transport increased by 4.5%, mainly as a result of an increase in the ton kilometer quantity flown, after setting off the yield per ton kilometer. In other income there was a decline of 8.9% compared to the equivalent period in the previous year, mainly as a result of the decline in revenues from providing maintenance services to external factors. Operating expenses Increased during the period of report by 1.9% compared to the equivalent period in the previous year, mainly as a result of an increase in expenses for jet fuel, as explained below, and from the increase in the fees and air nevigation. The Company's expenses for jet fuel increased by 5.2% compared to the equivalent quarter in the previous year. The increase stemmed mainly from the increase in the effective price of jet fuel (which includes the results of hedging operations that the Company took). It should be mentioned that the price of jet fuel in the market declined in the quarter under report compared to the equivalent quarter in the previous year, but the Company's hedging operations resulted in an increase in the effective price to the Company. The rate of jet fuel expenses to turnover increased from 30.3% in the equivalent quarter in the previous year to 34.1% in the quarter under report. Total hedging payments in the quarter under report aggregated $2.9 million compared to $2.4 b6

22 million receipts from hedging in the equivalent quarter in the previous year. In addition, the Company recorded an expense of $5.8 million as a result of changes in the fair value of the hedging transactions (income of $2.4 million in the equivalent quarter of the previous year). For additional details regarding the hedging of jet fuel prices, see section B1(3) below. Operating salary expenses declined during the period of report compared to the equivalent period in the previous year, mainly due to the effect of the evaluation in the rate of the shekel against the dollar on the Company's liabilities for employee benefits, see section A.3 below. The development in the average price of jet fuel in the market in the second quarter: cent/gallon There was a significant decrease of $ 2.9 million in the Company's security expenses in the quarter under report, compared to the equivalent quarter in the previous year, mainly due to an increase in the rate of the State's participation in the security expenses, to a rate of 97.5% of overall expenses The Company's gross profits for the reporting quarter aggregated $ million, comprising 18.0% of turnover compared to gross profits of $ million, comprising 24.8% of turnover in the equivalent quarter in the previous year. The gross profit rate in the third qarter 30% 25% 24.6% 24.4% 24.8% 20% 18.8% 18.0% 15% 10% 5% 0% b7