EL AL ISRAEL AIRLINES LTD.

Transcription

1 EL AL ISRAEL AIRLINES LTD. FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2011 (unaudited) CONTENTS SECTION A - UPDATE OF CHAPTER A TO 2010 ANNUAL REPORT SECTION B - DIRECTOR'S REPORT SECTION C - FINANCIAL STATEMENTS

2 Free Translation of the Hebrew Language - Hebrew Wording Binding Update to Chapter A (Description of Corporate Business) 1 to the 2010 Periodic Report ( the Periodic Report") of EL AL Israel Airlines Ltd. ( the Company ) The following are updates to Chapter A - a Description of the Corporation s Business: General The Group's Concise Consolidated Financial Statements (hereinafter: "the Interim Financial Statements") have been prepared in accordance with IAS 34, "Interim Financial Reporting". In the preparation of these Financial Statements the Group implemented accounting policy, rules of presentation and calculation methods identical to those implemented in the preparation of its Financial Statements for December and the year ending that date. Regarding the accounting policy implemented regarding investment in an affiliate, see Note 2d to the Financial Statements. To Item 6.1 Traffic in the International Aviation Industry and to Item (a) Changes in the Extent of Activity in the Field and its Profitability International Developments IATA data indicates opposite trends in September 2011 in passenger traffic and in cargo traffic. While passenger traffic (both international and domestic) saw a 5.6% increase (a higher rate than the 4.6% growth rate listed in August), cargo traffic saw a 2.7% decrease relative to September 2010, an additional decline after August, in which a 2.4% decrease was listed in cargo traffic. IATA also predicts a slowdown in passenger traffic in the fourth quarter. International traffic: international traffic levels listed in September 2010 was similar to that of July this year; this after the passenger traffic growth rate was lower in August. By regional cross-section: January-September 2010 vs. January-September 2010: ASK - Available Seat Kilometer number of seats offered for sale multiplied by the distance flown. 1 The update is pursuant to regulation 39A of the Securities Regulations (Periodic and Immediate Statements), and includes material changes or additions which took place in the Corporation's business with any matter that can be described in the periodic report. The update corresponds to the item numbers for Chapter 1 (Description of Corporate Business) within the Company's periodic report for the year 2010, which were published on March 23, 2011 ( ref ) a-1

3 Free Translation of the Hebrew Language - Hebrew Wording Binding RPK - FTK - PLF - AFTK Revenue Passenger Kilometer number of paying passengers multiplied by distance flown. Freight Ton Kilometer the weight in tons of paid cargo (including mail) multiplied by the distance flown Passenger Load Factor the occupancy rate in passenger flights (percentage of seats occupied). Available Freight Ton Kilometer total available cargo capacity (weight in tons of cargo including mail) offered for sale multiplied by the distance flown. In September the IATA revised its 2011 profits projection upward. According to the new estimate, airlines are expected to earn $6.9 billion in 2011 ($2.9 billion more than the previous IATA projection from June). The IATA emphasizes that despite this improvement, profitability for airlines is still very low, and constitutes just 1.2% out of the airlines total revenues, estimated at $594 billion. The main reasons for the improvement in the projection for 2011: Passengers: the IATA now predicts that passenger traffic will increase by 5.9% in 2011 (compared to a 4.4% increase in the IATA s forecasts from June); this, after a 6% increase was listed for passenger traffic during the accumulated period; that is, January-June The increase in passenger traffic comes as a result of the economic optimism noted in the first few months of the year. However, the general forecast is for a weakening and slowdown by the end of the year. Cargo: cargo traffic has been in a "frozen" state from the beginning of the year. The IATA reduced its yearly projected growth in cargo traffic from 5.5% to just 1.4%. Airlines are expected to fly 46.4 million tons of cargo in 2011 (compared to 48.2 million tons in the previous forecast from June). Air cargo transport peaked in May 2010, and in comparison, July 2011 saw a 4% drop in cargo traffic. According to IATA estimates, cargo traffic is not expected to recover before the beginning of Usage: the airlines managed to maintain high load factors, at 2010 levels, this due to largerthan-expected passenger traffic, alongside greater usage of passenger planes, the increase in plane usage led to an increase in the average cargo capacity in the cargo holds of passenger aircraft, and as a result the cargo load capacity dropped significantly, reaching just 45% in July. Fuel: the IATA predicts an average crude oil price of $110 a barrel (Brent crude prices) in 2011, unchanged from the previous IATA forecast from June. This price is 39% higher than the average price of $79.4 per barrel in The IATA estimates that airline fuel expenses will reach a sum of $176 billion, constituting 30% of total airline expenses. Yields: supply and demand conditions in the first half of the year are expected to balance out the weaker second half results. Therefore, the IATA will not be changing its June forecast, which predicted a 3% increase in yield per passenger. However, the excess capacity of cargo in aircraft cargo holds will result in there being no change in 2011 in yield per ton cargo, unlike IATA s previous forecast from June 2011, which predicted a 4% growth. Revenues: IATA projections for airline revenues remained almost unchanged. The large increase in passenger traffic will lead to airline revenues from passengers reaching $464 billion, $7 billion more than in the June 2011 IATA forecast. However, airline cargo revenues are expected to drop by $5 billion compared to the previous forecast and will reach $67 billion. a-2

4 Free Translation of the Hebrew Language - Hebrew Wording Binding In addition, the IATA has published its first forecast for The IATA predicts that 2012 will be a more difficult year for the airlines. The growth rate in 2012 will be lower than the growth rate in 2011 and airline profits are expected to drop to $4.9 billion, constituting just 0.8% of their total revenues, which will reach $632 billion. To Item 6.2 Traffic in the Israeli Aviation Industry and to Item (b) Changes in the Scope of Activity in the Field and its Profitability Developments in the Israeli Market According to data provided by the Central Bureau of Statistics, the third quarter of 2011 saw 1.46 million departures of Israelis via air, a 5% increase from the same quarter last year. In addition, in spite of the political instability and political events in countries in the region (Syria, Egypt, Tunisia, Libya and Yemen), this quarter saw 642,000 tourist arrivals via air (BGN and Eilat), a 6% increase over the same period last year. In this regard also note that the number of Israeli departures and tourist arrivals were influenced by a shifting of the holidays, meaning that Yom Kippur and Sukkoth both fell in October this year (belonging to the fourth quarter), while last year all of the Tishrei holidays(i.e. Rosh Hashana, Yom Kippur, and Sukkoth) fell in September (third quarter). According to IAA data, total international passenger traffic through BGN increased by 6.6% in Q vs. Q3 2010; the average load factor in passenger flights was 84.4%, similar to Q Following the Company s reports in the periodic report for the first quarter of 2011, regarding the interruption placed on jet fuel refueling at BGN, after an unidentified contaminant was discovered in refueling tanks at BGN, in September 2011 the Ministry of National Infrastructure published the report from the investigation committee appointed to examine the jet fuel crisis. The Ministry of National Infrastructure report determined, amongst other things, that the committee believes that the contaminant had been accumulating in the system for years and that a higher frequency of cleaning and maintenance works could have significantly reduced this accumulation. The committee also noted that despite the contamination, no aircraft had refueled using contaminated fuel, after the fuel pipe filtering system at BGN had successfully prevented the contaminant from entering airplane fuel tanks. The committee recommended that the Airports Authority stipulate the issuance of approvals for the operation of jet fuel storage or refueling facility on proper maintenance of the facilities, with special emphasis placed on cleaning the tanks and pipes more frequently. It also recommended setting up mechanisms to increase supervision of the quality of jet fuel and establishing more rigorous quality standards. To Item 6.3 Fluctuations in Jet Fuel Prices, and to Item Raw Materials and Suppliers Fuel The quarter ending September 30, 2011 saw a 47% increase in the average market price of jet fuel compared to the same quarter last year. The effective average jet fuel price paid by the Company rose by 23.7%, after hedging activities, compared to the same quarter last year. During the quarter fuel costs constituted 34.7% of the Company s turnover (in the third quarter of 2010 fuel costs constituted 29% of its turnover). The following data refers to jet fuel prices (markets basket), as quoted by Platts [1]. For further details, see Section b.1.(3) of the Board of Directors Report regarding the Corporations business. As of September 30, 2011 the Company held an inventory of jet fuel purchased from suppliers both in Israel and abroad, worth $8.4 million. [1] To the best of the Company's knowledge, Platts is a member of the McGraw-Hill Group which has provided information on the energy industry for over 75 years. Platts provides information and up-to-date analyses, among other things, on international prices and events pertaining to the petroleum, petrochemical, natural gas and electric and nuclear power markets. a-3

5 Free Translation of the Hebrew Language - Hebrew Wording Binding To 6.4 Fluctuations in Foreign Currency Rates As of September 30, 2011, the exchange rate of the U.S. Dollar vs. the NIS rose by 1.3% relative to September 30, 2010, and dropped by 4.6% relative to December As of September 30, 2011, the exchange rate of the U.S. dollar vs. the euro was revaluated by 0.1% relative to September 30, 2010, and devaluated by 1.7% relative to December 31, For further details, see Section b.1.(5) of the Board of Directors Report on the Corporations Business. To item 6.5 Interest Rate Fluctuations The average 3-month Libor rate dropped by 21.4% in the quarter ending September compared to the same quarter last year. For further details see Section b.1.(4) of the Board of Directors Report on the Corporations Business. 1. Passenger Aircraft Activity To Item Legislative Restrictions, Standards and Special Constraints Applying to the Field of Activity On August 3, 2011 the Company signed an understanding with the State of Israel, which is designed to arrange, if and when it comes into effect, the activity of the Israeli aviation security array ( the Understanding ). The Understanding mainly refers to a gradual increase in the State s participation in the security expense burden of Israeli airlines, from 60% (the current rate) to rates of 65% (in 2001), 70% (in 2012), 75% (upon the signing of the open sky agreement with the European Union) and 80% upon the implementation of the open skies agreement (as agreed upon in the understanding). Whether or not the understanding comes into effect is dependent on the passing of a Government resolution by no later than the end of The submittal of the understanding to the Government for a resolution, as noted, is subject to the signing of an additional agreement between the Company and the Foreign Ministry. The additional agreement between the Company and the Foreign Ministry was signed on November 6, 2011 and was approved by the Ministry of Finance. The agreement shall arrange, among other things, the employment of aviation security workers. To Item Market Developments in the Field of Activity, or Changes in the Characteristics of its Customers, Item , Structure of Competition in the Field of Activity and Changes Occurring Thereof, the Open Sky Policy Implementation of Open Sky Policy, Item 7.2 Services in the Field of Activity The following is a description of the main changes deriving from the Ministry of Transportation's Open Skies Policy: Czech Republic a new aviation agreement was signed between Israel and the Czech Republic in September According to the new agreement, Israeli and Czech airlines will be permitted to operate up to 36 weekly scheduled flights, instead of 12 flights to date. Furthermore, Israeli and Czech companies will be permitted to operate 7 weekly charter flights to any additional Czech and Israeli destinations. The agreement signed allows for the first time, the operation, of flights using code sharing between Israeli and Czech airlines and with airlines from third countries, which will be permitted to market seats on flights between the Czech Republic and Israel. According to the new agreement, both countries will be entitled to appoint additional airlines to operate flights on the Tel Aviv-Prague route, alongside El Al and CSA. The agreement allows the continued operations of Czech airline CSA, which had lost its concession for flights to Israel in favor of Smart Wings, which operates low cost flights and was originally selected to replace CSA. Starting October 30, 2011 Smart Wings began operating 4 weekly flights on the Prague-Tel Aviv route, alongside continued activity by CSA on the Prague-Tel Aviv route. In this regarding note that Smart Wings had up until now operated charter flights on the Tel Aviv-Prague route. a-4

6 Free Translation of the Hebrew Language - Hebrew Wording Binding Scheduled foreign airlines increased their capacity by 8% in the third quarter of 2011 and passengers increased at a similar rate of 9% compared to the third quarter of The Group s seat capacity in international flights decreased by remained unchanged in Q and passenger traffic decreased by 1%. In all, passenger traffic through BGN in the third quarter of 2011 increased by 6.6% and seat capacity for all airlines together increased by a similar rate of 6.5%. Over the course of the summer season; starting on March 27, 2011 and continuing until the end of October 2011, competition grew fiercer as a result of the entry of new airlines such as French airline Air Meditterrane, which began operating flights on the Paris-Tel Aviv route in April 2011 and Norwegian Airlines, which began operating weekly flights on the Stockholm Tel Aviv route starting late June 2011,as well as from increased capacity/frequencies by existing airlines such as Air France, which began operating 3 daily flights in July-August 2011 and Korean Air, which added a fourth weekly flight on the Tel Aviv-Seoul route starting September 2011 for a 2-month period. A number of airlines are expected to add flights in the fourth quarter: Alitalia added two weekly flights on the Tel Aviv-Rome route starting October 2011, and operates a total of 23 weekly flights instead of 21 previously. Aerosvit added an additional weekly flight on the Tel Aviv-Kiev route (a total of 14 weekly frequencies), a third weekly flight on the Odessa route as well as flights to Donetsk, Dnepropetrovsk and Simferopol, starting in October Easy Jet added a fourth weekly flight on the Tel Aviv-Basel route, starting November In addition, the airline FlyNiki is expected to begin its activity on the Tel Aviv-Vienna route in February The entry of this company, which operates according to a low-cost format, into activity in Israel is made possible by the aviation agreement between Israel and Austria that was renewed last year and expanded so as to allow the entry of additional air carriers besides El Al and Austrian Airlines. At the same time, upon transitioning to the Winter 2011/2012 in late October, other airlines are preparing for decreased demand and reduced seats, frequencies, and routes in preparation for the slow tourism season, for instance: Lufthansa, which will be operating its morning flight on the Tel Aviv-Frankfort route using a smaller aircraft, also announced that it would be reducing its frequencies over the course of the winter season and Dutch airline KLM and Belgian airline Brussels Airlines, which will be operating a smaller airplane on the Tel Aviv-Amsterdam route and on the Tel Aviv-Brussels route, respectively. Furthermore, Arkia will be discontinuing its flights to Moscow and Kiev for the duration of the winter season, and announced that it would be reducing frequencies on routes to Paris, Amsterdam and Rome. The company discontinued its activity on the Sao Paolo route on November 10, In October 2011 the Company announced that it would be discontinuing its direct flights to Odessa and Dnepropetrovsk in the Ukraine starting December The last flight to Odessa will depart on December 6, 2011, and to Dnepropetrovsk on December 8, 2011, this due to economic considerations and as part of the Company s streamlining, costs reductions, and optimization of its route network. The Company is considering the option of operating flights to connecting destinations within the Ukraine through a code sharing agreement with Ukrainian airline Aerosvit. Domestic Activity In its third quarter of 2011, the Company flew 57,000 passenger legs to Eilat and its share of domestic traffic to Eilat equalled 15%. In August 2011, the Minister of Transportation announced his intention to approve an additional daily flight to Eilat for the Company, based on the recommendations of the Civil Aviation Authority. According to the recommendation, the Company can increase its seat a-5

7 Free Translation of the Hebrew Language - Hebrew Wording Binding capacity to Eilat from 430 to 580 seats in each direction and operate 4 daily flights instead of the current 3, this subject to a hearing to be held on the issue for the Company as well as for Arkia and Israir. Furthermore, the recommendation includes an expansion of the restriction on granting benefits to frequent flyer club members for the Eilat route, in such a manner so as to forbid the distribution of free tickets (or under preferred conditions) to and from Eilat for passengers travelling on the Company s international routes. The Company filed a written response to the Civil Aviation Authority and in November 2011 the CAA informed the Company that it was rejecting its written claims, but found fit to clarify that its recommendations regarding restrictions on benefits on the route to Eilat did not apply to international passengers the Company sought to fly on flights to Eilat. Likewise, the CAA clarified that its recommendations regarding the flight number restriction and the number of seats do not include feeder flights to Eilat intended for international tourism, to which no amount restrictions apply. A final decision has yet to be received from the Minister of Transportation and Road Safety regarding the change in the terms of the license. To Item Technological Changes that May have a Material Impact on the Field of Activities An agreement was signed in November 2011 establishing a pricing system for the Company, which automatically updates the Company s prices in all distribution systems, according to strategies and rules defined in advance and revised from time to time. The system is expected to be implemented in the coming months. Over the course of October 2011 the Company signed an agreement with the IATA to join an SIS project that deals with uniform monetary accounting processes between airlines, moving from paper documents to e-invoicing. An SIS system is required in accordance with IAIA rules. Implementing the system will lead to changes and automation of existing work processes. The project is undergoing advanced development stages and the system is planned to be integrated in the Company at the beginning of Q Following the Company's 2012 periodic reports, it was decided to freeze the program for a comprehensive realization of an ERP plan and focus on replacing existing financial systems with ERP-based systems. SAP-based alternatives are being considered for maintenance and engineering, alongside designated solutions for the MRO field. Improvements were made to the Company s website over the course of the reported period, such as: improving the ordering process while improving the payment stage to a more convenient and user-friendly format, presenting luggage data in the ordering system and in addition, various technological and design improvements were applied. Furthermore, the Company improved its express check-in system and a new modernlooking boarding pass was designed. In the social networks, the Company has introduced a new, highly-designed international page serving as an umbrella scene for all pages of the Company's representatives and serving as a platform for traffic arriving in Israel through content and communications in English. This channel joins the Company's social media activity and helps increase user involvement in the El Al brand, encourage conversation and promote El Al in online search engines as well as increase sales on the site. The duty free site was upgraded in order to increase sales using pre-flight orders, and the site now offers a user friendly experience while offering products from a variety of categories. Pursuant to Section 7.2 of the Periodic Report - Services in the Area of Activity, Data Regarding Developments in Passenger Traffic by Central Destination Groups: In total, passenger traffic through BGN increased by 6.6% compared to the third quarter of Passenger traffic in the third quarter of 2011 was divided between the airlines in the following manner: El Al and Sun D'Or 31.5%; other scheduled airlines 47.3%; charter airlines 21.2%. a-6

8 Free Translation of the Hebrew Language - Hebrew Wording Binding Western European Routes Western European routes saw a 5% increase in total passenger traffic in the third quarter of 2011, compared to the same period last year; foreign scheduled airlines listed a 11% increase in passenger traffic and a 12% increase in seat capacity. The average load factor among foreign scheduled airlines was 84%. The prominent airlines which increased their activity in Q were: Iberia, which operated 17 weekly flights on the Tel Aviv-Madrid route in this quarter, compared to 14 weekly flights in Q Dutch airline KLM increased its seat capacity by 80% (by switching to a larger aircraft) and listed a 79% increase in passenger traffic. Air France added a third daily frequency on the Tel Aviv-Paris route and in total listed a 43% increase in its seat capacity and a 30% increase in passenger traffic. Belgian airline Jetair FlyAir operated 3 weekly frequencies this quarter on the Liege route compared to just 2 frequencies in Q and listed a 41% increase in passenger traffic on this route.. British low cost airline Easy Jet operated 7 weekly flights on the Luton-Tel Aviv route in this quarter compared to 6 flights on this route in Q and listed a 17% increase in its passenger traffic on this route. Easy Jet also expanded its activity on routes between Switzerland and Israel. In this quarter Easy Jet operated 4 weekly flights on the Tel Aviv- Geneva route and 3 weekly frequencies on the Tel Aviv-Basel route, compared to just 4 weekly flights on the Tel Aviv-Geneva route, which it operated during the third quarter of The Company increased its seat capacity by 8% and its passenger traffic increased by 7%; however, since subsidiary Sun D Or lost its operating license in April 2011, Sun D Or s activity on this route network decreased significantly (-36%), and therefore in total the Group s seat capacity (both El Al and Sun D Or) increased by just 2%, and the Group s passenger traffic remained mostly unchanged (+1%). The Group's average load factor in Q was 86.7% and its share of total passenger traffic in this route network was 35.7%. Routes to Central and Eastern Europe In total, international traffic on routes to Central and Eastern Europe increased by 3.7% in the third quarter of 2011 compared to the same quarter last year. Scheduled foreign airlines listed a slight (-2%) decrease in their seat capacity and a 6% decrease in their passenger traffic. The average load factor of scheduled foreign airlines was 74.6% in the third quarter of 2011 compared to 77.7% in the third quarter of Israeli airlines Arkia and Israir also listed a decrease in these routes as well (-10% and -76%, respectively). On the other hand, a significant increase (+31%) was listed in foreign charter company activity. The Company s seat capacity in this route network remained largely unchanged (+1%) and its passenger traffic increased by 2%. As stated above, in light of the revocation of Sun D Or s operational license, its activity on this route network decreased significantly (-45%), and in total the Group decreased its seat capacity on these routes by 13% and listed a similar decrease in passenger traffic. The Group's average load factor in this route network was 80.3%. Routes to the CIS Routes to Russia and CIS states listed an 18% increase in total passenger traffic and an 11% increase in seat capacity. Most of the increase was listed on routes between Russia and Israel (+17%) and between Ukraine and Israel (+31%). The increase in passenger traffic in the third quarter of 2011 derived from the expansion of the activity of airlines operating on these routes. Aeroflot began operating 5 weekly flights on the Moscow route starting August 2010 and starting April 2011 operates 7 weekly flights on this route. Ukraine Air International, which operated 8 weekly flights on the Tel Aviv-Kiev route in Q3 2011compared to 6 frequencies in Q Aerosvit and Donbasaero, which are controlled by the same owners, operated 24 weekly flights on routes between Ukraine and Israel in this quarter compared to 20 weekly a-7

9 Free Translation of the Hebrew Language - Hebrew Wording Binding flights it operated in the third quarter of During this period, the Group decreased the number of seats offered in this route network by 2% and it's passenger traffic on these routes increased by 3% compared to the same period last year, but as a result of the reduced activity by Sun D Or, a total decrease of 5% was listed in the Group s seat capacity and a slight drop of 1% was listed in the Group s passenger traffic. The Group's share of passenger traffic on these routes in Q was 24%. Transatlantic Routes Routes to the U.S. listed an 8% decrease in passenger traffic and a 5% decrease in seat capacity in this quarter. In this regard it must be noted that all airlines operating on these routes listed a drop in passenger traffic, with most of the drop listed for Delta, which operated just 4 flight on the Atlanta routes in July and August compared to 6 flights on this route in the same quarter last year, and listed a 56% drop in passenger traffic on this route. Also note that starting from the beginning of September, Delta discontinued its activity on the Tel Aviv-Atlanta route, in light of a strategic decision to streamline and cut costs on a number of international routes, balancing out the increase in fuel prices. Delta has suspended its service on the Tel Aviv-Atlanta route until further notice. Q saw no change in the Company s seat capacity on U.S. routes and the Company s passenger traffic dropped 3% compared to the corresponding quarter last year. East Asian Routes An increase of 7% occurred in passenger traffic on East Asian routes in Q along with an 11% increase in seat capacity for this route network. Most of the increase in passenger traffic and in seat capacity derived from the increase in the Company s activity on these routes and in particular on the Hong Kong route, in which the Company added a fifth weekly frequency and listed a 17% increase in its passenger traffic on this route. All in all, the Group increased its seat capacity on these routes by 12% and listed a 10% increase in passenger traffic. Korean Air, which operates flights on the Tel Aviv-Seoul route, increased its seat capacity by 6%, after adding a fourth weekly frequency in September (instead of 3 frequencies). Korean Air s passenger traffic in the third quarter of 2011 decreased by 8%. According to its announcements, Korean Air will continue to operate flights using this format for a two-month period in response to the peak holiday period and autumn demand. After that, Korean Air will return to operating 3 weekly frequencies, but starting November 2011 will replace its airplane for the Tel Aviv-Seoul route with a bigger aircraft. Regional Network A 14% increase in seat capacity was listed in the regional route network along with an 18% increase in passenger traffic compared to the third quarter of The increase in passenger traffic on these routes derives from the increase in passenger traffic to Turkey (+54%) and Greece (+11%). The most prominent airlines to increase their activity in this route network in the third quarter of 2011 were Aegean Airlines, which operated an average of 29 flights (7 scheduled) per week to Greece and the Greek Islands compared to just 21 flights (scheduled and charter) in the corresponding quarter last year, in total increasing its seat capacity and passenger traffic by 41%; and Turkish Airlines, which increased its passenger traffic by 29%, after operating 25 weekly flights compared to 23 flights in the third quarter of Note that the increase in the scope of traffic to Turkey constitutes a correction after the sharp drop in traffic listed following Operation Cast Lead and after the Turkish Flotilla events from May Following an additional worsening in Israeli/Turkish relations and in light of the lack of demand, Turkish charter flights announced that they would be discontinuing all charter flights to and from Israel starting September 15, This means that vacation flights between Israel and Turkey no longer exist. The flight activity continuing on the Tel Aviv-Antalya route will be of day flights for foreign tourists purchasing a one-day tourist package in Israel. a-8

10 Free Translation of the Hebrew Language - Hebrew Wording Binding At the same time, Turkish Airlines is continuing its scheduled flights on the Tel Aviv-Istanbul route. These flights are mostly used for connecting flights from Israel through Turkey. Note also that a sharp decrease was listed in traffic to Egypt (64%), in light of the riots breaking out in Egypt in January 2011 and the continuing political instability in Egypt. The Company operated a limited number of flights on this route in Q and it is continuing to adapt its activity on the route in accordance with developments in the region. In this period the Company operated routes to Cairo and Greece only. The Group s seat capacity on this route network decreased by 12% compared to the third quarter of 2010 and the number of Group passengers on this route also decreased at a similar rate. The Group s share of these routes reached a mere 9.5% in the third quarter of To Item 7.4 New Services Updates to the passenger luggage policy matching common practice in many European and American airlines, it was decided to update the Company's policy on the matter of passenger luggage for the Company's destinations in economy-class flights. Starting November 1, 2011, each passenger will be able to carry just one suitcase containing up to 23 kg of cargo. For a second suitcase, weighing up to 23 kg, an additional payment of $70 will be charged. This Company policy is compatible with that of major international airlines. Furthermore, payment for excess weight in a luggage unit starting November 1 will amount to a sum of just $25 for excess weight of between 23 and 32 kg. In September 2011 a memorandum of understanding was signed with Luxury Lounges Ltd. concerning the operation of a lounge for the Mauro corporation (the coffee manufacturer), in a space rented by the Company from the Port Authority at Newark Airport in New Jersey. The lounge will serve the Company s passengers and its passengers will be given preferred service. The lounge is expected to open in late In September 2011, an online sales site was launched on the Company s website, in conjunction with Best Buy, called Global Store. The store offers products complementary to the flight experience, both via direct sales and via tenders. Initially, the shop plans to provide paid products to anyone entering the site, and in the second stage, the option for frequent flyer club members to purchase products using points will be examined. The GlobaLY plan was launched for frequent flyer club members residing abroad. As part of this plan, the Company will donate the value of 5% of the total points accumulated by club members to the following purposes: Flying Jewish youth from outside the country to Israel to learn about the country and its people, in conjunction with the Taglit Organization. Flying lone soldiers to visit their families abroad, in conjunction with the AWIS. Fulfilling the wishes of children with life-endangering illnesses in conjunction with the Make-a Wish Foundation. The point contribution shall take place on a quarterly basis at the Company's expense only and plan members will be informed of the sum of points the Company contributed to the various organizations. Following the Company's reports in its 2010 periodic report regarding the code sharing agreement signed December 2010 with Ukrainian airline Aerosvit, the agreement was approved by both the Ministry of Transportation and the Anti-Trust Authority, and has entered effect starting November 1, The Company signed a cooperation agreement (on an interline basis) with regional Canadian airline West Jet; this agreement came into effect in September 2011 and allows the Company to offer its passengers a variety of follow-up destinations throughout Canada, South America and the Caribbean. a-9

11 Free Translation of the Hebrew Language - Hebrew Wording Binding To Item 7.10 Manufacturing Ability The Company s seat capacity (ASK) increased by 4.7% in the third quarter of 2011 (mainly due to added days of activity due to the shift in holiday dates), and the Company's RPK increased by 3.0% compared to the same quarter last year. Therefore, a 1.6% decrease was listed in its weighted load factor, reaching 82.4% compared to 83.8% in the same quarter last year. To Item 7.11 Aircraft Fleet in the Passenger Aircraft Field Following the Company s reports in the December 31, 2010 periodic report regarding its passenger aircraft fleet, the following are key changes: In July 2011 the Company signed an agreement with a subsidiary of the International Lease Finance Corporation to lease a ER aircraft, manufactured in 1998, starting in November 2011, for a lease period of 6 years. The airplane, which is undergoing inspection at a Boeing facility in China, is expected to begin service for the Company in December In late December 2011 the Company is expected to return its airplane (EBS) to its owners (M.K. Aviationa, S.A.). Adding winglets to airplanes as part of its attempt to reduce the impact of rising fuel prices on its flight expenses, the Company has decided to add winglets to the aircraft in its possession. A winglet is a vertical upward extension or backward pull of the ends of the wings of a fixed wing aircraft. Adding winglets is expected to save fuel. At this stage, winglets were added to a single aircraft, and over the course of the first half of 2012, winglets are planned to be installed on two additional aircraft. Over the course of October 2011, the Company removed two ER airplanes from Company service after 27 years of activity at the Company. 2. Cargo Aircraft Activity To Item Structure of the Field of Activity and Changes Occurring Therein According to the Company's estimates, the Group's share of cargo transport in July-September 2011 of all cargo shipped to and from Israel by air (including cargo carried in the cargo holds of passenger aircrafts, including mail activity but not including Sixth Freedom of the Air) amounted to 32.8%, this in comparison with 34.2% in the same period last year. To Item (a) Extent of Global Cargo Transport According to IATA reports, in January-September 2011, international transportation of cargo (including in passenger aircraft cargo holds) increased by 0.4% compared to the same period last year, an increase in activity at a lower rate that the projected yearly rate according to IATA estimates (5.6%). To Item (b) Extent of Cargo Transport on Aircraft to and from Israel. According to Airport Authority data, in July-September 2011, cargo traffic through BGN increased by 2.3% relative to the corresponding period last year. In January-September 2011 cargo traffic at BGN dropped by 1.6% relative to the corresponding period last year. To Item 8.2 Services in the Field of Activity. In August 2011 the Company entered into an agreement with Global GSA Group ( 3G ) to appoint it as general cargo agent in various European countries as well as to create a venture for business collaboration on flights originating from the same European counties in which 3G serves as a general cargo agent. To Item 8.5 Customers, Marketing and Distribution Following a court ruling, Agrexco (a Company client) was sold to a new owner (the Bickel company), after encountering financial difficulties. a-10

12 Free Translation of the Hebrew Language - Hebrew Wording Binding 3. Details on the Two Fields of Operations 9.1 Fixed Assets and Installations Terminal 3 Following discussions held between the Company and the Airports Authority, the Airports Authority announced that it would be extending and amending the contract for the operation of the Company's passenger lounge in Terminal 3 to November 1, To Item Employees Over the course of the reported period the Company certified and received 25 new pilots into service. Pursuant to Item of the Periodic Report, the following is an updated table on the Company's payroll as of September 30, 2011: September December Regular employees 3,852 3,814 Temporary employees 2,139 2,150 Total employees 5,991 5,964 To Item Israeli Employees Posted Abroad On August 16, 2011 the Company s Board of Directors approved the signing of an agreement to provide medical insurance services to employees of El Al and/or the State of Israel employed in various countries around the world, as well as for their families. This step was taken to streamline and lower total insurance costs, while adapting the standards in the insurance agreements to National Health Insurance requirements. To Item Executives and Senior Management Following the CEO s announcement regarding the establishment of the Excellence and People Fund for the developing, encouraging, and advancing the matters of both excellence at the Company and personal excellence. The Company established a committee to study the proposals made by the Company s employees including their compliance with certain criteria set for the purpose of winning the prizes, and in October 2011 the Company CEO, in a special ceremony, awarded the CEO s prizes for excellence for 2010 to the winning ten proposals. On November 16, 2011 the Company shareholders' general meeting confirmed the appointment of Ms. Yael Andoren to the Company s Board of Directors and the extension of the tenure of Prof. Yehoshua Shemer as an outside director for an additional 3-year term. To Item Sun D'Or International Airlines Ltd. ("Sun D'Or") Following the Company s reports regarding the cancellation of Sun D Or s operational license on April 1, 2011, Sun D Or continues to market the flights operated by it in the past which are carried out by the Company (on weekdays) as well as by other airlines (on weekend and holiday flights). Sun D Or acts as a tourism organizer while preserving the Sun D Or brand for charter flights marketed by it. Note that as a result of this change in activity, a significant 32% drop occurred in Sun D Or s total activity (on routes to Western, Central and Eastern Europe, and the Regional Network) in the third quarter of the year. Sun D Or recently submitted an official request to the CAA to receive a new operational license. The outlines of the activities and timetables allowing Sun D Or to return to operational activity have yet to be established. a-11

13 Free Translation of the Hebrew Language - Hebrew Wording Binding To Item Credit Line The Company s credit line amounted to $87 million as of September 30, 2011, (including $44 million from hedging institutions), $31 million of which were guaranteed frameworks. To Item Loans for Unique Use As of September 30, 2011, the balance of loans from banking and other corporations, including short term borrowings, amounted to $674.1 million. For further details regarding loans and a reportable credit event see details in the Board of Directors report. Following the agreement signed with R.B. Leasing Company Limited for the purchase of a passenger aircraft (ELH). In May 2010 the Company signed a loan agreement with a local bank to finance the purchase of the aircraft for the amount of $14.5 million. The loan is in USD and bears variable Libor interest plus a margin. Principal and interest payments are quarterly payments. The financing is for a period of 4 years. For the purpose of this loan the airplane was pledged to the local bank. One third of the sum of the loan was deposited at the local bank and is used as a source for lowering credit costs. In November 2011 the sum of the financing was raised by 39.5 million NIS. The loan is in NIS and bears Prime interest plus a margin. Principal and interest payments are quarterly payments. The financing is for a period of 4 years. In October 2011 the Company s Board of Directors ratified a loan agreement with a local credit card company according to which the Company will receive a 15 million NIS loan against the exercise of points. The loan was granted for a period of two years in monthly principal and interest payments at a Prime interest rate plus a margin. To Item (j) - Limitations and Supervision of the Corporation s Business Following the Company s reports, on October 11, 2011 an amendment was published to the Consumer Protection Regulations (Cancelling Transactions), 2010, according to which a cancellation right exists in frontal agreements for the purchase of tourism, vacation and flight services, within 14 days of the date of purchase, so long as the cancellation takes place 18 days (which are not days of rest) prior to the beginning of the service. In the event that the transaction is cancelled, the business may charge a cancellation fee of 5% of the value of the transaction or 100 NIS whichever is lower, in addition to credit clearance costs, if any. Not covered by the above are transactions involving services conducted entirely outside of Israel, including connecting flights to flights departing Israel which were provided through another airline and vacation packages outside of Israel, with the exception of flights included in a package that are flights from Israel and not connecting flights. This is under the condition that the business had informed the consumer of the cancellation terms for the service abroad prior to the engagement. On July 10, 2011 the Consumer Protection and Fair Trade Authority Commissioner published a directive according to which the Consumer Protection Law and resulting regulations pertaining to the cancellation of transactions in the field of tourism and aviation shall apply to airlines even when the deal is carried out between consumers and their travel agent and not directly with the airline. On August 4, 2011 an amendment was published to the Consumer Protection Regulations (Size of Type on Uniform Contract), 1995, which will come into effect on January , establishing various obligations pertaining to the terms included in information intended for consumers within the frameworks of various publications produced by commercial entities. The amendment establishes, among other things, requirements pertaining to the size of the letters in a publication, their shape, their color, typesetting and more. Furthermore, in July 2011 the Passenger Compensation and Assistance due to Flight Delay or Postponement Bill, 2011, submitted by MK Achmed Tibi, passed its first vote by the Knesset Economics Committee, stating that in cases of flight cancellations, flight delays or the refusal to permit a passenger to board a flight, under the terms and circumstances determined by the law, passengers shall be entitled to benefits such as free assistance, reimbursements, alternate tickets or even financial compensation. a-12

14 Free Translation of the Hebrew Language - Hebrew Wording Binding To Item Security Arrangements In October 2011 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 Holdings Ltd. According to the Agreement, QAS will provide the Company with certain security services at Ben Gurion Airport that are not provided by the Airports Authority, in accordance with U.S. TSA (Transportation Security Administration) requirements. In return for providing the services, the company will pay QAS a non-material payment reflecting what is in the Company s opinion the market price for similar services. The agreement is for a period of one year and the Company may terminate it with 30 days notice. This agreement was approved by the Company Board of Directors after the Company s Audit Committee determined that it was a non-exceptional transaction. The essence of the Board s arguments for approval were that QAS; which specializes in ground services, currently carries out similar security services based on TSA requirements for other foreign airlines flying to the U.S. that are subject to these requirements and has experience and expertise in these sort of services. Furthermore, in the opinion of the Board of Directors, after studying the presented alternatives, the engagement with QAS is the best offer the Company had received in economic and operational terms out of all of the alternatives presented. To Item 9.12 Essential Agreements In October 2011 the Company published a Request for Proposals ( RFP ) for fuel companies and for companies performing refueling services for the supply and refueling of jet fuel in Israel for the period beginning January 1, 2012 Following the Company's report in its June 2011 periodic report regarding the negotiations with fuel companies for the supply of jet fuel abroad, over the course of the third quarter, agreements were signed with some of the fuel companies abroad at an accumulated yearly scope of $210 million. To Item 9.14 Legal Proceedings Following Item of the Company s December 31, 2010 periodic report, the sum of the provision for the air cargo transport service prices civil suit in the U.S. was increased. This among other reasons is in light of advanced talks with the plaintiffs on the matter of a settlement. Following the Company's immediate report dated November 3, 2011 (ref: ) and the description in Section 9.14 to the Company's December 31, 2010 periodic report regarding a claim and a motion to approve it as a derivative claim submitted in May 2009 to the Tel Aviv District Court, (regarding the adjustment of cargo prices in the field of air cargo transportation to and from the United States, on November 2, 2011) the Company received the Court's ruling that it was dismissing the claim due to inaction. a-13

15 EL AL ISRAEL AIRLINES LTD Report of the Board of Directors on the State of the Corporation's Affairs For the Period Ending September 30, 2011 Overview 1.1 Points of Emphasis for the Reported Period We hereby present the Report of the Board of Directors on the State of the Corporation's Affairs for the period ending September Total passenger traffic through Ben Gurion Airport in the third quarter of 2011 amounted to 4.1 million passengers compared to 3.8 million passengers in the third quarter of 2010, a 6.6% increase, while airborne cargo increased by 2.3% to 71.9 thousand tons compared to 70.3 thousand tons in the same quarter last year. The Group flew some 1,289 thousand passenger legs and 24.9 thousand tons of cargo on international and domestic flights this quarter, a moderate 0.5% increase in passenger and a 7.2% increase in cargo tons compared to the same quarter last year. The Group s market share in international scheduled and charter flights amounted to 31.5% compared to 34.0% in the same quarter last year and the average load factor for the quarter was 82.4% compared to 83.8% in the same quarter last year. Key exogenous factors impacting the Company s operating results in the reported quarter compared to the same quarter last year were: a 47% increase in the average market price of jet fuel, a 21.4% average decrease in Libor interest rates, a 6.6% revaluation of the average rate of the NIS vs. the USD and a 8.8% revaluation of the average rate of the EUR vs. the USD. The Group invested a total of 23.0 million in fixed assets in the third quarter, and repaid $31.7 million in current loans. The Company s direct sales through its website and customer call center increased by 27% in the reported quarter relative to the corresponding quarter last year. In the third quarter of 2011 the Company saw an operational profit of $25.2 million compared to an operational profit of $55.6 million in the comparable quarter last year. The net profit for the reported quarter amounted to a total of $21.0 million compared to profits of $42.5 million in the third quarter of In the third quarter of 2011 the Company saw a cash flow from operating activities to the amount of $6.4 million (a negative cash flow of $46.6 million in the third quarter of 2010). The Group's cash balances, cash equivalents and short term deposits as of September amounted to a total of $127.7 million, while its equity as of September amounted to a total of $184.3 million. b-1

16 1.2 Changes in International Standards (IFRS) For further details regarding the standards and the impact of their application to the Group's Financial Statements, see Note 3 to the December Financial Statements. Regarding the implementation of IAS 28 due to the first-time achievement of material influence in Maman, see Note 2d to the Financial Statements. 1.3 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 freight on 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 freight in the holds of passenger aircraft, and provides ancillary services, such as the sale of duty-free products and the leasing of planes. In the field of passenger transport, the Company competes in its flights to and from Israel with 2 Israeli airlines (Arkia and Israir), with 60 foreign airlines that operate scheduled flights and over 60 foreign charter airlines. Revenues of this segment constituted 90.1% of the Group's total revenues in the third quarter of b) Cargo aircraft activity in this segment, the Group transports cargo in cargo aircraft. In the field of cargo transport, the Company competes with one Israeli airline (CAL) and with 6 foreign airlines operating cargo aircraft on a continuous basis, and with most of the scheduled airlines that operate passenger planes that carry cargo in their holds. Revenues from this area of activity constituted 3.7% of all of the Group s revenues in the reported period. The Group has additional revenues that are not assigned to its major areas of activity, which account for 6.2% of its total revenues. For further details regarding the Company's areas of activity, see Section 5a of the Board of Directors Report. b-2

17 a. Explanations of the Board of Directors for the State of the Corporation's Affairs: a.1 Financial Position (Consolidated Statements) change in thousands US dollars in thousands US dollars in thousands US dollars Current assets Cash and cash equivalents 119, ,002 8,372 Short-term deposits 8,362 63,565 (55,203) Trade receivables 163, ,960 30,045 Other accounts receivables 19,885 20,880 (995) Derivative financial instruments 2,247 42,190 (39,943) Prepaid expenses 31,249 26,995 4,254 Inventories 17,886 18,756 (870) Total current assets 362, ,348 (54,340) Non-current assets Long-term bank deposits 1,538 1,869 (331) Investment in affiliated companies 13, ,844 Investments in other companies 1,228 11,552 (10,324) Derivative financial instruments - 4,291 (4,291) Fixed assets, net 1,213,810 1,231,687 (17,877) Intangible assets, net 8,026 7, Prepaid expenses 6,564 8,121 (1,557) Assets due to employee benefits 37,494 38,799 (1,305) Total non-current assets 1,282,197 1,304,856 (22,659) Total Assets 1,644,205 1,721,204 (76,999) Current liabilities Borrowings and current maturities 97, ,587 (49,859) Trade payables 173, ,912 15,840 Other payables 48,224 49,625 (1,401) Provisions 36,808 44,939 (8,131) Derivative financial instruments 19,342 2,329 17,013 Employee benefit obligations 104,857 98,712 6,145 Unearned revenues 267, ,204 36,429 Total current liabilities 748, ,308 16,036 Non-current liabilities Loans from financial institutions 567, ,084 6,092 Employee benefit obligations 59,831 65,590 (5,759) Loan from others Derivative financial instruments 9,572 19,739 (10,167) Other payables 7,644 10,700 (3,056) Deferred taxes 21,274 32,792 (11,518) Unearned revenues 45,785 51,467 (5,682) Total non-current liabilities 711, ,372 (29,819) Shareholders equity 184, ,524 (63,216) Total liabilities and equity 1,644,205 1,721,204 (76,999) b-3

18 Main Changes in Asset, Liability and Shareholders' Equity Items as of September Current assets: The Company s current assets decreased by $54.3 million relative to December Most of the decrease derived from the drop in short-term deposits and derivative financial instruments. A seasonal increase was listed in the passengers item. The following changes occurred to the Company's derivative financial instruments (presented in the Financial Statements under 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 $51.1 million decrease compared to fair value at the end of 2010, as a result of transactions reaching redemption, from transactions sold and 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 decrease in the fair value of derivative financial instruments was expressed in a $21.2 million decrease (net after tax) in the capital reserve in respect of cash flow hedges recognized directly in equity, in an $6.9 million net increase in deferred tax liability, in an $3.3 million net increase in fuel and financing expenses in the Statement of Operations and in an $19.7 million net increase in cash balances as a result of the sale of jet fuel hedging transactions recognized for accounting purposes and from the purchase of jet fuel hedging options. For further details see b.1.(3), b.1.(4) and b.1.(5) below and Note 9 to the Financial Statements. Non-current assets: The Company s non-current assets decreased by $22.7 million as of September relative to December A decrease occurred in the fixed assets item On the one hand, an increase was listed as a result of the purchase of a aircraft, the payment of advance payments on account of a aircraft transaction, the purchase of an spare engine for the 737 fleet and the purchase of parts and accessories and other fixed assets totaling $84.6 million, while on the other hand this item decreased as a result of the depreciation accumulated in the period. Investment in affiliates increased as a result of a receipt of an additional portion of 3.75% from Maman s stock capital. Due to the first-time achievement of material influence in Maman, the investment listed in the December 31 Financial Statements under investment in other companies was classified in this report under investment in affiliated companies ; for further details see Note 6a to the Financial Statements. In addition, a decrease occurred in the fair value of non-current financial derivatives as detailed above. Current liabilities: The Company s current liabilities increased by $16.0 million relative to December Most of the increase derived from the increase in unearned revenues from the sale of flight tickets deriving mainly from advance sales for the Tishrei holidays. The trade payable item increased both as a result of seasonality and as a result of rising prices, mainly in jet fuel prices. The financial derivatives item increased as explained above. An increase was also noted in employee benefit liabilities due to changes in salary payment dates. The short-term credit and current maturities items were reduced significantly as a result of loan restructuring (see Note 10 to the Financial Statements). A decrease was listed in the provisions item as a result of the payment of the agreed-upon debt to Income Tax deductions (see Note 6e to the Financial Statements), offset in part by the listing of an additional provision for a civil cargo claim in the U.S. (see Note 27.c.b.(3) to the December Financial Statements, as well as Note 11d to the September Financial Statements). b-4

19 Non-Current Liabilities: The Company s non-current liabilities decreased by $29.8 million relative to December Most of the decrease derived from the net deferred tax liability item, mainly as a result of the loss for the period. An increase was also listed in the liability in the derivative financial instruments items as explained above. Drops were also listed in unearned revenues, due to frequent flyer club points and in employee benefit liabilities mainly due to an increase in current maturities of early retirement plans. The loans item saw an increase as a result of loan restructuring and from reclassification to current liabilities. Shareholders equity Equity decreased by $63.2 million in the reported period relative to December 31, The decrease in shareholders' equity is primarily due to a loss in the period and by a decrease in capital reserves due to cash flow hedging, as a result of a decrease in the fair value of hedging agreements recognized for accounting purposes in the Company s possession. As of September , the Company has a working capital deficit of $386.3 million, compared to a deficit of $316.0 million on December The Company s current ratio as of September amounted to 48.4 %, compared to 56.9% as of December The main reason behind the increase in working capital deficit was a decrease in the balance of short-term deposits as well as a decrease in the fair value of financial derivatives and a seasonal increase in unearned revenues. The increase in the deficit was partially offset, mainly by a reduction in the short-term credit item and current maturities, in the provisions item as well as an increase in trade receivables. 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, the vast majority of the working capital deficit is not cash-flow based and allows the Company to redeem its liabilities. a.2 Analysis of El Al s Business Results a.2.1 Market Data Passenger and cargo July - September July - September change traffic at BGA in thousands in thousands in thousands % Incoming tourists * % Departing Israelis * 1,462 1, % Cargo import - tons ** % Cargo export - tons ** % b-5

20 Passenger and cargo January - September January - September change traffic at BGA in thousands in thousands in thousands % Incoming tourists * 1,874 1, % Departing Israelis * 3,078 2, % Cargo import - tons ** % Cargo export - tons ** (7.2) (6%) * Source: Central Bureau of Statistics. ** Does not include cargo in transit. Incoming Tourist & Departing Israeli Traffic, in the Third Quarters of (In Thousands): 1,252 1,263 1,298 1,391 1,462 1,750 1,500 1,250 1, Incoming tourists Departing Israelis * Source: Central Bureau of Statistics. Imports & Exports of Cargo by Air to and from Israel, in the Third Quarters of (In Thousands of Tons): Export Import Source: Civil Aviation Authority. b-6

21 a.2.2 Company Operating Data* July - September July - September change Passenger leg (scheduled and chartered) - in thousands 1,289 1,283 0% RPK (scheduled) - in millions 5,098 4,947 3% ASK (scheduled) - in millions 6,185 5,907 5% Load factor (scheduled) 82.4% 83.8% (2%) The Company's market share (scheduled and chartered) 31.5% 34.0% (7%) Flown cargo, in thousand tons % RTK - in millions % Weighted flying hours (including leased equipment) - in thousands (*) % Average man-years (El AL only): Permanent 3,848 3,827 1% Temporary 2,414 2,285 6% Total 6,262 6,112 2% January - September January - September change Passenger leg (scheduled and chartered) - in thousands 3,245 3,153 3% RPK (scheduled) - in millions 13,314 13,120 1% ASK (scheduled) - in millions 16,575 16,044 3% Load factor (scheduled) 80.3% 81.8% (2%) The Company's market share (scheduled and chartered) 33.7% 36.7% (8%) Flown cargo, in thousand tons % RTK - in millions % Weighted flying hours (including leased equipment) - in thousands (*) % Average man-years (El AL only): Permanent 3,859 3,821 1% Temporary 2,243 2,063 9% Total 6,102 5,884 4% Aircraft in operation - end of period - number of units Average age of owned fleet at the end of the period - in years (0.1) * Operating data refers both to international and domestic activity. 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. b-7

22 a.3 Statement of Operations Data for the Quarter Ending September (Consolidated Financial Statements): The key factors that influenced the business results in the three month period ending September compared to the same period last year: July - September July - September change in thousands US dollars % of operating revenues in thousands US dollars % of operating revenues in thousands US dollars % Operating revenues 602, % *565, % 36,490 6% Operating expenses (488,939) (81.2%) (426,182) (75.4%) (62,757) 15% Gross profit 113, % 139, % (26,267) (19%) Selling expenses (59,789) (9.9%) *(58,984) (10.4%) (805) 1% General and administrative expenses (23,671) (3.9%) (23,189) (4.1%) (482) 2% Other operating expenses, net (4,507) (0.7%) (1,599) (0.3%) (2,908) 182% Operating loss before financing 25, % 55, % (30,462) (55%) Financing expenses (4,731) (0.8%) (12,186) (2.2%) 7,455 (61%) Financing income 7, % 3, % 3, % The Company's share of the profits of subsidiaries, net of tax % - 0.0% 319 Loss before income taxes 28, % 47, % (18,835) (40%) Tax expenses (7,204) (1.2%) (4,602) (0.8%) (2,602) 57% Loss for the period 21, % 42, % (21,437) (50%) * Restated - see Note 5 to the Financial Statements. The Company's revenues increased by $36.5 million in the third quarter of 2011 relative to the corresponding period last year, a 6.5% increase, however the sharp 47% increase in average jet fuel market prices which increased expenses (before hedging activities) by $65 million relative to the same quarter last year (a total $45.3 million increase after hedging and changes in activity), increase fuel expenses to a rate of 34.1% of turnover (compared to 28.3% in the third quarter of 2010). The revaluation of the average NIS exchange rate (6.6%) and that of the euro (8.8%) relative to the USD in the reported period, also contributed to a further increase in the Company s operating costs. On the other hand, the NIS/USD exchange rate as of September dropped by 8.7% relative to the June rates. As a result, a decrease was listed in the Company s NIS liabilities in dollar terms, which reduced the Company s expenses Operating revenues operating revenues increased 6.5% in the reported quarter, as noted above, relative to the same quarter last year. Passenger revenues increased both due to a 3% increase both in the number of passenger kilometers transported by the Company and an increase in the yield per passenger kilometer as well as the revaluation of the exchange rate of the euro relative to the dollar. Cargo shipping revenues also increased as a result of the 9% increase in the amount of cargo-km flown. Operating expenses the third quarter of 2011 saw a 14.7% increase in the Company's operating expenses compared to the corresponding period last year, mainly as a result of the increase in jet fuel expenses as detailed below as well as the revaluation of the average rate of the period of the NIS and the euro relative to the dollar and current price increases. The operating expenses rate increased from 75.4% in the third quarter of 2010 to 81.2% in the reported quarter. The Company's jet fuel expenses increased by $45.3 million relative to the corresponding quarter last year, a significant 28.3% increase. Fuel expenses constituted 42.0% of all operating expenses in the reported quarter compared to 37.6% in the third quarter of The market prices for jet fuel increased by an average of 47% compared to the same quarter last year, while the Company's effective price after hedging activity increased by 23.7%. In the reported quarter the Company received jet fuel refunds payments to the amount of $16.3 million, which were charged to gain/loss (relative to $17.3 million in hedging payments in the corresponding quarter last year). The drop in the fair value of hedging agreements, not b-8

23 recognized for accounting purposes, charged to gain/loss increased jet fuel expenses for the quarter by $8.2 million. For further information on jet fuel price hedging see b.1.(3) below. Salary expenses in the third quarter of 2011 decreased relative to the same period last year. Most of the decrease derived from the devaluation of the NIS vs. the USD as of the report date relative to the rate on June , which reduced NIS obligations to employees for compensation, vacation and illness, in dollar terms. 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 gross profit rate dropped from 24.6% of turnover in the third quarter of 2010 to 18.8% in the reported quarter. Selling expenses selling expenses did not undergo any material changes relative to the corresponding quarter last year; their rate dropped from 10.4% in the third quarter of 2010 to 9.9% in the reported quarter. General and administrative expenses general and administrative expenses remained unchanged relative to the same quarter last year, with their share of turnover dropping from 4.1% to 3.9% in the reported quarter. Other net expenses in the reported quarter the Company listed other net expenses to the amount of $4.5 million, mainly as a result of an additional provision for a civil cargo suit in the U.S. (see Note 11.d to the Financial Statements), compared to an expense of $1.6 million in the corresponding quarter last year. Operational profit in the reported quarter amounted to $25.2 million, 4.2% of turnover, compared to an operational profit in the corresponding quarter last year of $55.6 million, 9.8% of turnover. Financing the Company listed net financing revenues of $2.7 million in the reported quarter, compared to net financing expenses of $8.6 million in the corresponding quarter last year. Most of the change derives from a drop in interest hedging payments, from revenues listed due to exchange rate differences and from receipts due to exchange rate hedging transactions. Pre-tax profit in the reported quarter amounted to $28.2 million compared to a pre-tax profit of $47.1 million in the corresponding quarter last year. Net profit for the period amounted to $21.0 million, 3.5% of turnover, compared to a profit of $42.5 million, 7.5% of turnover in the corresponding quarter last year. b-9

24 The key factors that influenced the business results in the nine month period ending September compared with the same period last year are: January - September January - September change in thousands US dollars % of in operating thousands revenues US dollars % of operating revenues in thousands US dollars % Operating revenues 1,557, % *1,491, % 66,601 4% Operating expenses (1,362,495) (87.5%) (1,190,710) (79.9%) (171,785) 14% Gross profit 195, % 300, % (105,184) (35%) Selling expenses (160,663) (10.3%) *(160,487) (10.8%) (176) 0% General and administrative expenses (72,935) (4.7%) (69,810) (4.7%) (3,125) 4% Other operating expenses, net (13,162) (0.8%) (4,221) (0.3%) (8,941) 212% Operating profit (loss) before financing (51,501) (3.3%) 65, % (117,426) Financing expenses (15,188) (1.0%) (27,839) (1.9%) 12,651 (45%) Financing income 19, % 6, % 12, % Company's share in earnings of affiliates, net 1, % 0 0.0% 1,199 Profit (loss) before income taxes (45,830) (2.9%) 44, % (90,802) Tax benefit (expenses) 4, % (4,200) (0.3%) 8,411 Profit (loss) for the year (41,619) (2.7%) 40, % (82,391) * Restated - see Note 5 to the Financial Statements. Operating revenues operating revenues in the first nine months of 2011 increased by 4.5% compared to the corresponding period last year. Net passenger revenues increased mainly as a result of the increase in yield per passenger kilometer and from changes in exchange rates. Cargo shipping revenues increased, mainly as a result of the increase in cargo traffic and the increase in yield per ton kilometer. Operating expenses the first nine months of 2011 saw a 14.4% increase in the Company's operating expenses compared to the corresponding period last year, mainly as a result of the increase in jet fuel and salary expenses as detailed below as well as the increase in activity in the reported period, current price increases and the revaluation of the rate of the NIS and the EUR relative to the USD. The gross profit rate decreased from 20.1% of turnover in the first nine months of 2010 to 12.5% in the reported period. Salary expenses in the first nine months of 2011 increased relative to the same period last year. Most of the increase derived from the revaluation of the NIS relative to the USD, from the increase in activity and from the application of the salary agreement. 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 in the first nine months of 2011 increased by $91.5 million relative to the corresponding period last year, a 20.6% increase. Fuel expenses constituted 39.4% of all operating expenses in this period compared to 37.3% in the corresponding period last year. Market prices for jet fuel increased by an average of 45% compared to the first nine months of 2010, while the Company's effective price after hedging activity increased by 17.5%. The Company listed jet fuel refunds to the amount of $52.7 million in the reported period, which were charged to gain/loss (relative to $55.7 million in hedging payments in the corresponding quarter last year). The drop in the fair value of hedging agreements, not recognized for accounting purposes, charged to gain/loss increased jet fuel expenses for the period by $18.9 million. For further information on jet fuel price hedging see b.1.(3) below. Selling expenses selling expenses did not undergo any material changes relative to the corresponding period last year. Total selling expenses amounted to 10.3% of turnover compared to 10.8% in the corresponding period last year. b-10

25 General and administrative expenses General and administrative expenses increased relative to the first nine months of 2010, primarily due to the increase in salary expenses. Their share of the turnover stayed at 4.7%, similar to their rate in the first nine months of Other net expenses in the first nine months of 2011 the Company listed other net expenses to the amount of $13.2 million, mainly as a result of an additional provision for a civil cargo suit in the U.S. (see Note 11d to the Financial Statements). The Company listed other expenses to the amount of $4.2 million in the first nine months of Operational loss for the first nine months of 2011 amounted to $51.5 million, 3.3% of turnover, compared to an operational profit in the comparable period last year of $65.9 million, 4.4% of turnover. Financing the Company listed net financing revenues of $4.5 million in the first nine months of 2011, compared to net financing expenses of $21.0 million in the corresponding period last year. Most of the change derives from a drop in interest hedging expenses and from receipts due to NIS exchange rate hedging. Pre-tax loss for the January-September period amounted to $45.8 million compared to a pre-tax profit of $45.0 million in the corresponding period last year. Loss for the period amounted to $41.6 million, 2.7% of turnover, compared to a profit of $40.8 million, 2.7% of turnover in the corresponding period last year. b-11

26 a.4 Effect of Changes in the Exchange Rate on the Company's Severance Pay Liabilities In the three month period ending September the exchange rate of the shekel decreased against the dollar by 8.7%, compared to an increase in the exchange rate of the shekel against the dollar of 5.4% in the same quarter last year. In the nine month period ending September the exchange rate of the shekel decreased against the dollar by 4.6%, compared to an increase in the exchange rate of the shekel against the dollar of 2.9% in the same period last year. US Dollar - NIS Exchange Rate: The Company has a net obligation to its employees for severance pay, retirement plans, sick pay and vacation pay as of September to the amount of $79 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 USD, which causes differences deriving from changes in the exchange rate of the shekel against the dollar. Exchange rate changes are not one-directional, and lead to 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. The quarter ending September saw a decrease in expenses for this element to the amount of $5.6 million compared with the same period last year, in which the expenses for this element amounted to $4.2 million. The first nine months of 2011 saw a reduction in the expenses for this element to the amount of $3.1 million, compared to the same period last year, in which expenses were listed for this element to the amount of $2.5 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: b-12

27 Before After neutralizing the exchange-rate effect Three-month period on the accrued severance pay ended September 30, (in thousands US dollars) Operating expenses 488, , , ,645 Gross profit 113, , , ,946 Gross profit rate 18.8% 24.6% 18.1% 25.1% Selling, general and administrative expenses 83,460 82,173 84,030 81,830 Other operating expenses,net (4,507) (1,599) (5,299) (262) Operating profits before financing 25,175 55,637 19,554 59,854 Operating profits rate before financing 4.2% 9.8% 3.2% 10.6% Profit for the period 21,025 42,462 15,404 46,679 Profit rate for the period 3.5% 7.5% 2.6% 8.3% Before After neutralizing the exchange-rate effect Nine-month period on the accrued severance pay ended September 30, (in thousands US dollars) Operating expenses 1,362,495 1,190,710 1,364,865 1,189,341 Gross profit 195, , , ,812 Gross profit rate 12.5% 20.1% 12.4% 20.2% Selling, general and administrative expenses 233, , , ,113 Other operating expenses, net (13,162) (4,221) (13,609) (3,241) Operating profit (loss) before financing (51,501) 65,925 (54,637) 68,458 Operating profit (loss) rate before financing (3.3%) 4.4% (3.5%) 4.6% Profit (loss) for the year (41,619) 40,772 (44,755) 43,305 Profit (loss) rate for the period (2.7%) 2.7% (2.9%) 2.9% b-13

28 a.5 Segment Reporting Presented below are operational segment data on a consolidated basis: a. General: 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 (through 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. Starting June 2011 the Company employs a single leased cargo airplane. In determining the results of the reported operating segments, a number of components not part of the direct costs involved in operating the flights, such as depreciation as a result of aviation equipment, fixed maintenance costs and fixed costs at overseas offices are also included. b. Analysis of income and results by operating segments: For Three-month period ended : passenger aircraft cargo aircraft others Adjustment Total consolidated in thousands US dollars operating revenues revenue from external customers 542,500 22,381 10,579 26, ,081 inter-segment revenues ,127 (23,127) - Total segment revenues 542,500 22,381 33,706 3, ,081 segment results 68,782 (547) 8,754 76,989 Unassigned expenses (51,814) Operating profit before financing 25,175 Financing expenses (4,731) Financing income 7,466 The Company's share of the profits of subsidiaries, net of tax 319 Profit before income taxes 28,229 Tax expenses (7,204) Profit for the period 21,025 b-14

29 For Three-month period ended : passenger aircraft cargo aircraft others Adjustment Total consolidated in thousands US dollars operating revenues revenue from external customers 503,112 18,251 11,054 33, ,591 inter-segment revenues ,962 (30,962) - Total segment revenues 503,112 18,251 42,016 2, ,591 segment results 95,158 (1,153) 10, ,361 Unassigned expenses (48,724) Operating profit before financing 55,637 Financing expenses (12,186) Financing income 3,613 The Company's share of the profits of subsidiaries, net of tax - Loss before income taxes 47,064 Tax expenses (4,602) Profit for the period 42,462 The increase in revenues from passenger planes in the reported quarter relative to the same quarter last year derives mainly form an increase in the number of passenger-kilometers and an increase in yield per passenger-kilometer and ton-kilometer. At the same time, the increase in receipts and in particular in jet fuel prices and in the revaluation of the rate of the NIS and the euro relative to the dollar, reduced the profitability of the passenger plane segment from 18.9% in the third quarter of 2010 to 12.7% in the reported quarter. Cargo plane revenues increased past the increase in production receipt and therefore the quarterly result was a loss of 2.4% compared to a 6.3% loss in the corresponding quarter last year. The decrease in the profitability of the passenger plane segment in the reported quarter relative to the corresponding quarter last year and the increase in expenses not attributed directly to operating segments, led to a move from operating profit of $55.6 million for the Company as a whole in the third quarter of 2011 to an operating profit of $25.2 million in the reported quarter For Nine-month period ended : passenger aircraft cargo aircraft others Adjustment Total consolidated in thousands US dollars operating revenues revenue from external customers 1,387,563 76,735 33,045 60,411 1,557,754 inter-segment revenues ,200 (53,200) - Total segment revenues 1,387,563 76,735 86,245 7,211 1,557,754 segment results 105,516 (844) 23, ,345 Unassigned expenses (179,846) Operating loss before financing (51,501) Financing expenses (15,188) Financing income 19,660 The Company's share of the profits of subsidiaries, net of tax 1,199 Loss before income taxes (45,830) Tax benefit 4,211 Loss for the period (41,619) b-15

30 For Nine-month period ended : passenger aircraft cargo aircraft others Adjustment Total consolidated in thousands US dollars operating revenues revenue from external customers 1,335,816 57,750 31,548 66,039 1,491,153 inter-segment revenues ,192 (64,192) - Total segment revenues 1,335,816 57,750 95,740 1,847 1,491,153 segment results 189,174 (2,021) 24, ,022 Unassigned expenses (146,097) Operating profit before financing 65,925 Financing expenses (27,839) Financing income 6,886 The Company's share of the profits of subsidiaries, net of tax - Profit before income taxes 44,972 Tax expenses (4,200) Profit for the period 40,772 Revenues in the nine-month period ending September in the passenger plane segment increased relative to the corresponding period last year, mainly as a result of an increase in revenues per passengerkilometer and ton-kilometer of cargo and from an increase in tons of cargo shipped inside the bellies of passenger planes. The increase in operating costs, in particular in jet fuel prices and in salary expenses and in the revaluation of the rate of the NIS and the euro relative to the dollar, reduced the profitability of the segment from 14.2% in the first nine months of 2010 to 7.6% in the corresponding period in The cargo plane segment saw an increase in revenues in the first nine months of 2011 as a result of the increase in the amount of cargo shipped and an increase in yield per ton-kilometer. In this period the segment listed a 1.1% loss compared to a 3.5% loss in the first nine months of The decrease in the profitability of the passenger plane segment in and the increase in expenses not attributed directly to operating segments, led to a move from operational profits of $65.9 million for the Company as a whole in the first nine months of 2010 to an operational loss of $51.5 million in the first nine months of passenger aircraft For year ended: cargo aircraft others Adjustment Total 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 ,573 (78,573) - Total segment revenues 1,765,282 87, ,363 2,086 1,972,239 segment results 251,825 (264) 28, ,134 Unassigned expenses (192,091) Operating profit before financing 88,043 Financing expenses (35,911) Financing income 10,849 The Company's share of the profits of subsidiaries, net of tax 45 Profit before income taxes 63,026 Tax expenses (5,971) Profit for the year 57,055 b-16

31 a.6 Seasonal Factors The Group's activity is seasonal and focuses on peak periods. Heavy traffic of Israeli residents traveling abroad occurs primarily during the summer months and during holidays, while heavy incoming tourist traffic occurs during the summer months and during Jewish or Christian holidays or vacation time in their countries of origin. a.7 Liquidity and Financing Sources Movement in cash flow for the three month period ending September compared to the same period last year is: July - September July - September change in thousands US dollars in thousands US dollars in thousands US dollars Cash flows from operating activities 6,441 46,575 (40,134) Cash flows used for investing activities (2,468) (41,280) 38,812 Cash flows used for financing activities (34,816) (21,579) (13,237) Net decrease in cash and cash equivalents (30,843) (16,284) (14,559) Operating Activities The Group received a cash flow from current activity to the amount of $6.4 million in the quarter ending September compared to a cash flow from current activity to the amount of $46.6 million in the same quarter last year. The worsening in the current cash flow relative to the same quarter last year derives mainly from the reduced profits for the period as well as from changes in asset and liability items. Investment Activities The Company made a net investment of $2.5 million in investment activity in the third quarter of Investment in fixed and intangible assets amounted to a total of $23.4 million (mainly payments for the aircraft agreement and purchase of spare parts and accessories). On the other hand, the Company received $20.7 million from the realization of short-term deposits. In the third quarter of 2010, the Company invested a net sum of $41.3 million. Investment in fixed and intangible assets amounted to $11.0 million. Investment in net short term deposits amounted to $30.5 million. Financing Activities In the third quarter of 2011 the Company used a net of $34.8 million for financing activity, mainly for the current redemption of long-term loans and for the reduction of current credit from banking corporations. In the third quarter of 2010 the Company used $21.6 million for financing activity, mainly for the redemption of long-term loans from banking corporations. b-17

32 In total, the reported quarter saw a $30.8 million decrease in the balance of cash and cash equivalents, which amounted to $119.4 million as of September compared to $150.2 million on June Movement in cash flow for the nine month period ending September compared to the same period last year is: Jan - September Jan - September change in thousands US dollars in thousands US dollars in thousands US dollars Cash flows from operating activities 83, ,301 (99,980) Cash flows used for investing activities (29,937) (54,452) 24,515 Cash flows used for financing activities (45,012) (76,053) 31,041 Net increase in cash and cash equivalents 8,372 52,796 (44,424) Operating Activities The Group received cash flows from operating activity to the amount of $83.3 million in the nine months ending September compared to cash flow from operating activity to the amount of $183.3 million in the same period last year. The change derives mainly from the loss in the first nine months of 2011 compared to the profit listed by the Company in the corresponding period last year. Investment Activities In the first nine months of 2011, the Company made investments at a net sum of $29.9 million. Investment in fixed and intangible assets amounted to a total of $85.9 million (mainly the purchase of a plane, payments for planes and the purchase of parts and accessories). On the other hand, the Company received $55.2 million from the realization of short-term deposits. In the first nine months of 2010, the Company invested a net sum of $54.5 million. Investment in fixed and intangible assets amounted to $32.3 million and the increase in short-term deposits amounted to 30.3 million. On the other hand the Company received $5.5 million from the realization of restricted deposits and $2.5 million from the realization of fixed assets. Financing Activities In the first nine months of 2011 the Company used a net of $45.0 million for financing activity, mainly for the redemption of long-term loans to the amount of $62.6 million and the repayment of short-term bank credit to the amount of $1.2 million. On the other hand, the Company received loans to the amount of $18.8 million in the reported period. In the first nine months of 2010 the Company used $76.1 million for financing activity, mainly for the redemption of long-term loans to the amount of $51.9 million and the repayment of short-term bank credit to the amount of $26.6 million. On the other hand, the Company received loans to the amount of $2.5 million in this period. In total the balance of cash and cash equivalents as of September increased by $8.4 million and reached a total of $119.4 million, compared to $111.0 million as of December The Company's material loans and credit frameworks: Following Legal Position of the Securities Authority dated October , regarding a reportable credit event, the Company has established that the threshold of materiality for the purpose of detailing material loans is 5% of the consolidated Company s balance sheet total. b-18

33 Regarding a table detailing the material loans based on the criteria established above, see Appendix B to the Board of Directors Report below. Note that the Company has additional loans as of September that are not material as defined above, as detailed in this report. In the matter of additional details pertaining to the Company s loans and compliance with financial restrictions and covenants, see Note 22 to the December 31, 2010 yearly Financial Statements. b-19

34 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 US in the price of a gallon of jet fuel during an entire year impacts the Company's fuel expenses by $2.3 million. The Company has taken hedging measures to reduce the exposure, as detailed in b.1.(3) below. Changes in jet fuel may influence the scope of securities the Company may be required to deposit with jet fuel hedgers. The Company is taking steps to hedge this exposure. 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 $6.7 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. According to the Company's estimates, at present levels of activity, each 1% in appreciation of the exchange rate of the shekel relative to the dollar for an entire year increases the Company's annual expenses by $4 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 their 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 due 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 Financial Statements. b-20

35 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 Market Risk Management Committee headed by Mr. Nadav Palti, which is responsible for determining the 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 rate was set for hedging out of total expected consumption, in a gradual and decreasing manner. Therefore, the maximum hedging rate at the beginning of the period was 80% and the minimum hedging rate at the end of the period was 20%. Starting 2011, 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 hedging rate would be set out of total expected consumption, in a gradual and decreasing manner. Hedging agreements shall be carried out on a monthly basis. The maximum hedging rate at the beginning of the period is 75% and the minimum hedging rate for the 12th month is 5%. Instruments and hedging levels shall be selected in such a manner that the Company limits its maximum exposure to cash securities. As of this report, according to the Board of Directors Committee for Market Risks Management, the Company is not in compliance with the minimum levels defined in the policy. The Company's policy with respect to interest hedging is to hedge half of the credit portfolio for a period of up to 5 years. As of this report, the Company is hedged according to its policy. The Company's policy with respect to NIS/USD exchange rates in 2010 was to hedge up to half of its shekel exposure for up to one year forward. Starting 2011 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 management. As of this report, the Company is hedged according to its policy. 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 after the balance sheet date, see Section e. below. b-21

36 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 September , the Company entered into several agreements for the purpose of hedging jet fuel prices, at a scope estimated at 55% of expected consumption for October-December 2011 and 9% of expected consumption for Some of these transactions are recognized as hedging agreements for accounting purposes and some are not. The net fair value of all jet fuel hedging instruments as of September is a negative sum of $9.9 million, presented in the Financial Statements in the framework of current assets and current liabilities, under "Derivative Financial Instruments. In the reported quarter the Company listed a net income of $8.1 million for these hedging agreements. For details regarding the jet fuel instrument swap carried out by the Company in March 2011, see Note 9b to the Financial Statements. For details regarding changes in jet fuel prices sand changes to part of the hedging portfolio subsequent to the balance sheet date, see Section e(b) of the Board of Directors Report below. b.1.(4) Hedging Interest on Loans The Company executes hedges of the exposure in its long-term credit portfolio, due to changes in interest rates, in accordance with its policy as laid out in Section b.1.(2) above. As of September these transactions are not recognized as hedging agreements for accounting purposes. The fair value of these agreements as of September is a negative sum of $11.6 million, which is presented in the Financial Statements in the framework of current and non-current liabilities under "Derivative Financial Instruments. After executing these hedges, as of September , 35.9% of the balance of the Company's loans is at fixed interest for a thirteen-month horizon. In addition, as of September the Company has a balance of loans to the amount of $92.0 million at fixed interest for a period of 10 years constituting 13.6% of all of the Company's loans, so that as of the date of the report, 53.1% of the Company's loans are fixed-interest. The Company listed a net expense of $0.1 million for these hedging agreements in the reported quarter. For information on changes in interest rates occurring subsequent to the balance sheet date, see Section e.(3) of the Board of Directors Report below. b-22

37 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. Over the course of Q the Company entered into several financial transactions, designed to protect the Company from drops in NIS/USD exchange rates by October These transactions are recognized as hedging agreements for accounting purposes. The net fair value of these instruments as of September is a negative sum of $5.2 million, presented in the Financial Statements in the framework of current assets and current liabilities, under "Derivative Financial Instruments. In the reported quarter the Company listed income for exchange rate hedging agreements to the amount of $4.1 million. For details on changes in the NIS/USD exchange rate occurring subsequent to the balance sheet date, see e.(d) below. b-23

38 b.1.(6) Sensitivity Analysis Reporting The following is an analysis of the sensitivity of the fair value of the financial instruments sensitive to changes possible in the risk factors to which they are exposed. The analyses are given relative to the fair value of the financial instruments as of September 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 Increase 10% NIS/$ Increase 5% NIS/$ Fair value NIS/$ Gain (loss) from changes Decrease 5% NIS/$ Decrease 10% NIS/$ Cash and cash equivalents (2,978) (1,560) 32,758 1,724 3,640 Short-term deposits (760) (398) 8, Trade receivables (486) (254) 5, Other accounts receivables (710) (372) 7, Derivative financial instruments (94) (49) 1, Long-term bank deposits (140) (73) 1, Total financial Assets (5,167) (2,707) 56,839 2,992 6,315 Trade payables 2,869 1,503 (31,560) (1,661) (3,507) Other payables - Current (1,667) (88) (185) Derivative financial instruments (6,235) (328) (693) Other payables - Non Current (4,437) (234) (493) Total financial liabilities 3,991 2,090 (43,899) (2,310) (4,878) Exposure in linkage balance sheet due to surplus of financial liabilities over financial assets (1,177) (616) 12, ,438 b-24

39 b) Sensitivity to changes in euro/dollar exchange rate - in thousands of dollars: Gain (loss) from changes Increase 10% Euro/$ Increase 5% Euro/$ Fair value Euro/$ Gain (loss) from changes Decrease 5% Euro/$ Decrease 10% Euro/$ Cash and cash equivalents (248) (130) 2, Trade receivables (1,685) (883) 18, ,059 Other accounts receivables (22) (12) Total financial Assets (1,955) (1,024) 21,505 1,132 2,389 Trade payables 2,846 1,491 (31,304) (1,648) (3,478) Other payables (4,121) (217) (458) Total financial liabilities 3,220 1,687 (35,425) (1,864) (3,936) Exposure in linkage balance sheet due to surplus of financial liabilities over financial assets 1, (13,920) (733) (1,547) c) Sensitivity to changes in jet fuel prices on inventory (dollar/gallon) in thousands of dollars: Gain from changes Type of instrument Increase 10% $/gallon Increase 5% $/gallon Fair value * $/gallon Loss from changes Decrease 5% $/gallon Decrease 10% $/gallon Jet fuel Inventorie ,443 (422) (844) * The price of jet fuel according to a moving weighted average for the period ending September d) Sensitivity of jet fuel hedge 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 , jet fuel prices changed by 14%, and therefore the following sensitivity analysis includes a 15% change in jet fuel prices. Gain from changes Loss from changes Type of instrument Increase 15% Increase 10% Increase 5% Fair value* Decrease 5% Decrease 10% Decrease 15% 3.366, , , , , , , $/gallon $/gallon $/gallon $/gallon $/gallon $/gallon $/gallon SWAP transactions - designed for hedging 8,805 5,870 2,935 (2,471) (2,935) (5,870) (8,805) Options - not designed for hedging 4,606 3,293 1,769 (7,412) (1,991) (4,158) (6,384) Total transactions - jet fuel hedge 13,411 9,163 4,704 (9,883) (4,926) (10,028) (15,189) * The price of jet fuel in the Mediterranean Basin ($2.869/gallon) and Northwest Europe ($2.927/gallon) as of September , according to which the fair value of the Company's hedge transactions is calculated. b-25

40 e) Sensitivity of interest hedge to changes in market interest rates in thousands of dollars: According to the principles of the model, the Group executed interest hedges that respond in a similar way to market factors (IRS agreements 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 risk, as a result of the grouping. On December a 75% change occurred to the dollar monetary interest rate, and therefore the following sensitivity analysis led to a 75% change in interest rates. Type of instrument Increase 75% in interest rate Gain from changes Increase 10% in interest rate Increase 5% in interest rate Fair value ** Decrease 5% in interest rate Loss from changes Decrease 10% in interest rate Decrease 75% in interest rate IRS transactions - not designed for hedging (11,584) (38) (93) (692) * Fair value was calculated according to the market Libor rate as of the balance sheet date, at the following rates: 3-month Libor: 0.37%, 6-month Libor: 0.56%, and 12-month Libor 0.86%, all as applicable and according to the relevant transaction. f) Sensitivity of NIS/USD exchange rate hedge to changes in market interest rates in thousands of dollars: Loss from changes Type of instrument Increase 10% in exchange rate Increase 5% in exchange rate Gain from changes Decrease 10% in exchange rate Decrease 5% Fair value NIS/$ * in exchange rate FORWARD transactions - designed for hedging (33,026) (16,513) (5,200) 16,513 33,026 * The sensitivity analysis was conducted in shekel terms, and the profit or loss in the event of a 5% and 10% decrease or increase was translated according to an exchange rate of NIS per $1 on September b-26

41 b2. Linkage Basis Report The following is the consolidated linkage basis report for September 30, 2011: In, or linked to In Israeli In, or linked to In, or linked to Non-monetary Total the US dollar currency the euro the other items currencies (in thousands US dollars) Current assets Cash and cash equivalents 71,283 32,758 2,727 12, ,374 Short-term deposits - 8, ,362 Trade receivables 126,345 5,341 18,535 12, ,005 Other accounts receivables 10,066 7, ,771-19,885 Derivative financial instruments 1,212 1, ,247 Prepaid expenses ,249 31,249 Inventories ,886 17,886 Non-current assets Long-term bank deposits - 1, ,538 Investment in affiliated companies ,537 13,537 Investment in other company 1, ,228 Fixed assets, net ,213,810 1,213,810 Intangible assets, net ,026 8,026 Prepaid expenses ,564 6,564 Assets due to employee benefits , ,494 Toal assets 210,277 94,190 21,505 27,161 1,291,072 1,644,205 Current liabilities Short term borrowings and current maturities (97,625) (54) (49) - - (97,728) Trade payables (98,518) (31,560) (31,304) (12,370) - (173,752) Other payables (38,314) (1,667) (4,121) (4,122) - (48,224) Provisions (19,899) (16,909) (36,808) Derivative financial instruments (13,107) (6,235) (19,342) Employee benefit obligations (3,945) (99,556) (669) (687) - (104,857) Unearned revenues (267,633) (267,633) Non-current liabilities Loans from financial institutions (567,176) (567,176) Employee benefit obligations (6,442) (48,094) (656) (4,639) - (59,831) Loan from others (271) (271) Derivative financial instruments (9,572) (9,572) Other payables (3,207) (4,437) (7,644) Deferred taxes (21,274) (21,274) Unearned revenues (45,785) (45,785) Shareholders equity (184,308) (184,308) Total liabilities and equity (858,076) (208,512) (36,799) (21,818) (519,000) (1,644,205) Monetary assets, net of monetary liabilities (monetary liabilities, net of monetary assets) (647,799) (114,322) (15,294) 5, ,072 - b-27

42 The following is the consolidated linkage basis report for September 30, 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 120,631 20,974 6,619 11, ,483 Short-term deposits 30,054 8, ,254 Restricted deposits 1, ,500 Trade receivables 122,319 1,287 14,437 12, ,279 Other accounts receivables 8,064 7,373 1, ,600 Derivative financial instruments 9,221 7, ,546 Prepaid expenses ,320 22,320 Inventories ,426 15,426 Non-current assets Long-term bank deposits - 1, ,784 Investment in affiliated companies Investment in other companies 4, ,034 Derivative financial instruments 4,609 1, ,623 Fixed assets, net ,246,457 1,246,457 Intangible assets, net ,923 7,923 Prepaid expenses ,430 8,430 Assets due to employee benefits , ,107 Total assets 300,556 82,940 22,289 24,425 1,301,204 1,731,414 Current liabilities Short term borrowings and current maturities (152,060) (1,289) (25) (1,158) - (154,532) Trade payables (100,102) (24,580) (24,676) (12,877) - (162,235) Other payables (42,000) (3,026) (4,086) (3,636) - (52,748) Provisions (5,407) (56,127) (61,534) Derivative financial instruments (6,258) (6,258) Employee benefit obligations (2,429) (94,271) (425) (304) - (97,429) Unearned revenues (235,179) (235,179) Non-current liabilities Loans from financial institutions (581,297) (581,297) Employee benefit obligations (7,831) (48,833) (723) (5,287) - (62,674) Derivative financial instruments (20,238) (20,238) Other payables (6,206) (4,437) (10,643) Deferred taxes (24,169) (24,169) Unearned revenues (51,598) (51,598) Shareholders equity (210,880) (210,880) Total liabilities and equity (923,828) (232,563) (29,935) (23,262) (521,826) (1,731,414) Monetary assets, net of monetary liabilities (monetary liabilities, net of monetary assets) (623,272) (149,623) (7,646) 1, ,378 - b-28

43 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, ,002 Short-term deposits 55,000 8, ,565 Trade receivables 104,504 1,114 14,879 12, ,960 Other receivables 10,551 8, ,098-20,880 Derivative financial instruments 30,020 12, ,190 Prepaid expenses ,995 26,995 Inventory ,756 18,756 Non-current assets Long-term bank deposits - 1, ,869 Investment in affiliated companies Investments in other companies 1,228 10, ,552 Derivative financial instruments 4, ,291 Fixed assets, net ,231,687 1,231,687 Intangible assets, net ,844 7,844 Prepaid expenses ,121 8,121 Assets due to employee benefits , ,799 Total assets 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) Derivative financial instruments (19,739) (19,739) Other payables (6,263) (4,437) (10,700) Deferred tax (32,792) (32,792) Unearned revenues (51,467) (51,467) Shareholders equity (247,524) (247,524) Total liabilities and equity (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, ,109 - b-29

44 c. Aspects of Corporate Governance Disclosure in the Report of the Board of Directors Regarding the Financial Statements Approval Process The body charged with entity-level 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, the Finance and Budget Committee, the Balance Sheet Committee, the Security Committee, the Corporate Governance Committee and the Government Affairs and Regulations Committee. In the Board meeting held on September it was decided to split the Finance, Budget and Balance Sheet Committee to two committees: the Finance and Budget Committee which will discuss various financial issues, including the Company s budget, as well as a balance sheet committee that will serve as a Financial Statements examination committee. At the head of both committees is the external director Mr. Yair Rabinowitz. The Balance Sheet Committee (Financial Statement Examination Committee) currently consists of the following four members (most of whom are independent): 1) Mr. Yair Rabinowitz, Chair of the Committee, external 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. Rabinowitz provided a statement (as defined in the regulations) prior to his appointment. 2) Professor Yehoshua Shemer, external 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 activity, mainly in managing major corporations and is capable of and experienced in reading financial statements. Professor Shemer provided a statement (as defined in the regulations) prior to his appointment. 3) Mr. Pinchas Ginsburg, director, possessing accounting and financial qualifications, economics and accounting graduate from Tel Aviv University. Serves as CEO of Hillel & Co. travel agency. Mr. Ginsburg is qualified and has extensive experience in understanding financial statements and has provided a statement (as this term is defined in the Regulations) prior to his appointment. 4) Mr. Amnon Lipkin-Shahak, independent director, with professional qualifications. General History graduate from the Tel Aviv University and Chairman of Tahal s Board of Directors. Mr. Lipkin-Shahak has provided a statement (as defined in the regulations) prior to his appointment. The Balance Sheet Committee meets for extensive and thorough discussion of the draft Financial Statements, in the presence of the auditing accountant. The Chief Executive Officer and the Chief Financial Officer present the members of the committee with extensive details on the Financial Statements, including detailed financial analyses about the Company's performance during the reporting period. b-30

45 The Balance Sheet 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. When complex or material issues are on the agenda, special discussions are held by the Balance Sheet Committee on the issues on the agenda with the participation of the independent auditor. The Company s Board of Directors is the organ responsible for discussing and approving the Financial Statements, after the members of the Board receive the draft Financial Statements and the recommendations of the Financial Statements Examination Committee at least two business days prior to the meeting. Over the course of the Board 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, the Chair 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 independent auditor, who provide remarks and clarifications to the Financial Statements and who are the Board members disposal to answer questions and provide clarifications regarding the reports prior to their approval. The Balance Sheet Committee convened on November to formulate recommendations for the Board of Directors. Taking part in the meeting in question were the following Committee members: Yair Rabinowitz, Professor Shuki Shemer and Mr. Pinchas Ginsburg. Also taking part in the meetings in question were the Chairman of the Board of Directors, Mr. Amikam Cohen, the Company CEO, Mr. Eliezer Shekedi, the CFO, Mr. Nissim Malki, the Legal Counsel and Company Secretary, Mr. Omer Shalev, Esq., the Company Auditor, Gil Barr, CPA and representatives of the independent auditor. The Balance Sheet Committee held a discussion about the Financial Statements presented to it, including directing questions to the members of management present and to the independent auditor. Likewise, the independent auditor is asked to present his comments, if any, to the committee members, including accounting policy applied and special events that arose during the review of the Financial Statements. The following are details of the processes taken prior to the approval of the September Financial Statements: a. The draft Financial Statements were provided to the members of the Board of Directors to study on November b. Committee members are welcome to contact the Company CFO at any time with any question or clarification they require, prior to the meeting. c. Over the course of the meeting, the Committee reviewed the Company s financial results and viewed comparisons between the reported period and corresponding periods and the work plan, presented by the CFO. b-31

46 d. Pursuant to its meeting the Committee studied the estimates and assessments carried out in relation to the Financial Statements for the reported quarter, the wholeness and propriety of disclosure in the Financial Statements for the reported quarter, the accounting policy adopted and accounting treatment implemented regarding the Company's material issues. e. The Committee discussed the effectiveness of internal controls over financial reporting and disclosure in the Company and examined, among other things, the manner of treatment of the material weakness reported by the Company in its 2010 Financial Statements. The Committee was presented with a review by Company management regarding actions taken by the Company to correct the material weakness, including progress of the preparation of an administrative enforcement plan that will be brought before the Company s Board of Directors for approval. Furthermore, the Committee was informed that as of the date of the report s approval, no event or issue has occurred to change the evaluation of the effectiveness of internal controls, as presented pursuant to the latest yearly report. In addition, also presented to the Committee were the actions taken by the Company to ensure that despite the material weakness, its reports had been prepared properly. f. At the conclusion of the discussion, and after it has been clarified that the Financial Statements adequately reflect the state of Company affairs and its operating results, the Committee recommended to the Board of Directors to approve the Financial Statements. g. The Committee s recommendations were provided to the members of the Board of Directors on November in writing along with the draft Financial Statements. h. On November 22 a discussion was held by the Company s Board of Directors regarding the recommendations of the Financial Statements Examination Committee. At the conclusion of the Board meeting, the September Financial Statements, prepared on the basis of IFRS rules, were approved unanimously. Present at the Board of Directors Meeting in which the Financial Statements were approved, were the following Board members: Amikam Cohen, Tamar Moses-Borovitz, Yehudah (Yudi) Levi, Amnon Lipkin-Shahak, Eran Ilan, Ami Saggis, Yair Rabinowitz, Professor Yehoshua Shemer, Shlomo Hannael, Pinchas Ginsburg and Sofia Kimmerling. The recommendations of the Balance Sheet Committee were provided the Board of Directors 6 business days prior to the discussion on the Financial Statements by the Company s Board of Directors. b-32

47 d. Disclosure Provisions with Regard to Financial Reporting by the Corporation: d1. Events Subsequent to the Balance Sheet Date Regarding events subsequent to the balance sheet date, see Note 14 to the September Interim Financial Statements. d2. Critical Accounting Estimates The implementation of accounting standards by the Company's management while preparing financial statements occasionally involves various assumptions, assessments and estimates influencing levels of the assets and liabilities and the business results reported in the Financial Statements. Some of the assumptions, assessments and estimates are critical to the financial position or operating results reflected in the Group's Financial Statements, due to their materiality, complexity of the calculations or likelihood of realization of uncertain matters. For details on the material estimates included in the Financial Statements see Note 4 to the December Financial Statements. d3. Explanation of the Matter to which the Company's Independent Auditors Draw Attention in their Report on the Financial Statements The Company's accountants draw attention, in their opinion on the Financial Statements, to Note 1e to the Interim Financial Statements, regarding the plan by Company management to improve its business results and cash flows. The matter to which the independent auditors drew attention does not constitute a change in the uniform wording of the auditors report. b-33

48 e. Additional Information: Disclosure regarding Changes in the Economic Environment, the Implications of the Capital Market Crisis, Market Risks and Special Events a) The international aviation industry is affected by the economic and security situation and by unusual events, such as the outbreak of epidemics and natural disasters in the world in general, and in specific areas in particular, as well as by the economic situation in Israel and around the world. In the period subsequent to the report date, the economic crisis in the euro block has continued, particularly in Greece and Italy, and a renewed increase was noted in oil process. The following are changes occurring to jet fuel prices, interest rates and NIS exchange rates from the end of the second quarter until immediately before the publication of the September 30, 2011 Financial Statements: b) As of the Balance Sheet date (September 30, 2011) the price of jet fuel in the Med region was cents per gallon, while as of immediately prior to the approval of the report this price was cents per gallon, a 8.0% increase. Note that jet fuel expenses constitute nearly 35% of the Company s turnover, and therefore the price changes may have a material impact on its financial results. The average effective price the Company is expected to pay for jet fuel consumption (after hedging) in October-November 2011 is similar to the average effective price paid in the third quarter. At the same time, the fair value of jet hedging instruments shall be set in accordance with price changes that occurred since the end of the year and the completion of accounting for some of the transactions. Subsequent to the report date, the Company changed part of the structure of its hedging portfolio by repurchasing sell options it wrote within the framework of cylinder agreements, the purchase was carried out at a profit of $3 million compared to the fair value of these options as of the report date. Over the fourth quarter of 2011 the Company is expected to list income of $16.4 million in its books as a result of hedge agreements sold in March 2011 (see Note 8b to the March 31, 2011 Financial Statements). c) The three-month Libor rate saw an increase from 0.37% as of the report date to 0.49% immediately prior to the report s approval, an 30% increase. 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 fourth quarter of 2011 shall be made according to interest rates in previous quarters. The Company possesses hedging agreements for Libor rates (see Section b.1.(4) above), the fair value of which is expected to drop as a result of the decrease in Libor interest rates. d) Subsequent to the balance sheet date, no material changes occurred in the exchange rate of the NIS vs. the USD. The Company has hedging agreements on the NIS/USD exchange rate (see b.1.(5) above), the fair value of which may change according to changes in exchange rates. Note that the impact of exchange rates on next quarter's operating results shall be determined based on exchange rates in effect throughout the quarter and at its conclusion (December 31, 2011). Subsequent to the balance sheet date the Company, in accordance with its policy, carried out an additional hedging agreement to hedge the exchange rate of the NIS relative to the USD at 75% of the exposure expected for November Elyezer Shkedi CEO Amikam Cohen Chairman of the Board November 22, 2011 b-34

49 Appendix A to the Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending September 30, 2011 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), Assessment of the Total Value of the Fleets a. Introduction International Accounting Standard 36 establishes rules regarding the accounting treatment, presentation and disclosure required in the event of the impairment of assets. The purpose of the standard is to establish procedures the corporation must implement in order to ensure that these assets are not presented in sums higher than their recoverable amount. An asset is presented in the Financial Statements at higher than its recoverable amount when its book value is higher than the sum received from the use or sale of the asset. In the event that the asset has an impairment, IAS 36 demands that the corporation recognize an impairment loss. The following document presents the key points of the value estimate performed by El Al Israel Airlines Ltd. (hereinafter "El Al" or "The Company") in order to determine whether the depreciation of its and fleets (hereinafter "the Fleets") was to be recognized according to IAS 36, in accordance with Securities Authority directives. This document was prepared in accordance with guidelines from the Securities Authority as per Section 8b of the Securities Regulations (Periodic and Immediate Reports), 1970, regarding minimal required disclosure for value assessments and in their regard and rules regarding their addition to reports. b. Specification and Identification of Asset Group The asset group for which the test was conducted includes the fleet which consists of 6 aircraft owned by the Company and the fleet which consists of 6 aircraft owned by the Company. b-35

50 c. Opinion Validity Date November The value estimate was based on financial projections for 2011 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 depreciation must be made when the book value of an asset surpasses its recoverable amount. A recoverable amount is calculated as asset's the 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 September 30, 2011 Financial Statements is greater than their selling price. As of this value assessment, the selling price of the fleet amounts to a total of $445 million, compared to the depreciated retained cost in the books of those aircraft as of September 30, 2011, which amounts to a total of $501 million. b-36

51 The selling price of the fleet amounts to a total of $164 million, compared to the depreciated retained cost in the books of those aircraft as of September , which amounts to a total of $237 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 employed in calculating value: Useful life: for the fleet - 12 years of activity in average (and sale of the aircraft at net selling price at the end of the 12 year period), for the fleet - 7 years of activity in average (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 aircraft fleet will amount to $83 million in 2011, and the cash flow from the operation of the aircraft fleet will amount to $96 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. Scrap value at the end of useful life (meaning after 12 years for the fleet and 7 years for the fleet): calculated based on AVAC and Airclaims projections and totaling $180 million for the fleet and $74 million for the 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 is based on the projection for 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 was assumed to equal the same fixed rate as in the 2011 projection. b-37

52 The current tax rate expected for the Company for the coming 7-12 year period is zero. 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 fleet (in millions of dollars): Total discounted cash flow Total Capitalized Scrap Value (After 12 Years) Total Total value of the above assets based on the discounted cash flow method: $724 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 value in use projections: b-38

53 Discount Rate Yearly Contribution 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% In Millions of Dollars Fuel price sensitivity analysis, use of the asset across 12 years: Fuel Price (Cent per Gallon) Yearly Contribution NPV Reduced Value Difference of NPV Vs. Reduced Value In Millions of Dollars b-39

54 h. Value set using the Discounted Cash Flow Method for the fleet (in millions of dollars): Total Total discounted cash flow Total capitalized scrap value (after 7 years) Total value of the above assets based on the discounted cash flow method: $561 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 value in use projections: Discount Rate Yearly Contribution 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% In Millions of Dollars b-40

55 Fuel price sensitivity analysis, use of the asset across 7 years: Fuel Price (Cent per Gallon) Yearly Contribution NPV Reduced Value Difference of NPV Vs. Reduced Value In Millions of Dollars i. Summary The following table presents the summarized value assessment as of September for the fleet: Recoverable Sum Calculation Net Selling Price (Net Selling Price) Value in Use (Value in use) for El Al In Millions of Dollars Recoverable Sum Whichever is Higher for El Al b-41

56 Should Impairment be Listed in the Books? The Aircrafts' Depreciated Retained Cost as of September The Recoverable Amount of the Same Aircraft to El Al, as of September In Millions of Dollars Should Impairment be Listed in the Books? No The following table presents the summarized value assessment for the fleet as of September : b-42

57 Recoverable Sum Calculation Net Selling Price (Net Selling Price) Value in Use (Value in use) for El Al In Millions of Dollars Recoverable Sum Whichever is Higher for El Al Should Impairment be Listed in the Books? The Aircrafts' Depreciated Retained Cost As of September The Recoverable Sum of the Same Aircraft to El Al, As of September In Millions of Dollars Should Impairment be Listed in the Books? No This value assessment is accurate on the date of its preparation and is based upon monetary details for 2011 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-43

58 Appendix B to the Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending September 30, 2011 The Company s Material Loans and Credit Frameworks - As of September 30, 2011* Loan Characteristics Local banking institution (**) Foreign banking institution with EXIM guarantee EXIM (**) Aircraft Loan Scope of Loan (Thousands of Dollars) Unpaid Balance (Thousands of Dollars) 737, , , , , ,261 92,024 Securities: three aircraft, three aircraft, one aircraft, one aircraft two aircraft three aircraft Interest Variable: Libor + margin 2.31%- 2.75%. Variable: Libor + margin (-0.01%) to 0.8% Fixed 3.62%- 4.01% *The credit currency of all of the loans detailed above is the U.S. dollar. Principal and Interest Repayment Frequency Quarterly Quarterly Clearance Board Scope of Principal Repayment (Thousands of Dollars) Up to January : 9,250, starting April : 6,700 Between 2,762 and 4,466 Baloon Balance (Thousands of Dollars) Quarterly 2,360 - Loan Start Date Final Repayment Date Requirement to Attribute Value of Collateral to Uncleared Balance 78,000 13/01/ /07/ % Financial Covenants Ratio of Value of Collateral to Uncleared Balance as of December % meets financial covenants Ratio of Value of Collateral to Uncleared Balance as of September % meets financial covenants 59,299 23/07/ /07/ /04/ /04/ /05/ /05/ /06/ /06/ **A cross default mechanism exists between the various loans of the same banking institution. b-44

59 Appendix B to the Report of the Board of Directors on the State of the Corporation's Affairs for the Period Ending September 30, 2011 The Company s Material Loans and Credit Frameworks - As of November 15, 2011* Loan Characteristics Local banking institution (**) Foreign banking institution with EXIM guarantee EXIM (**) Aircraft Loan Scope of Loan (Thousands of Dollars) Unpaid Balance (Thousand of Dollars) 737, , , , , ,261 91,251 Securities: three aircraft, three aircraft, one aircraft, one aircraft two aircraft three aircraft Interest Variable: Libor + margin 2.31%- 2.75%. Variable: Libor + margin (-0.01%) to 0.8% Fixed 3.62%- 4.01% *The credit currency of all of the loans detailed above is the U.S. dollar. Principal and Interest Repayment Frequency Quarterly Quarterly Clearance Board Scope of Principal Repayment (Thousands of Dollars) Up to January : 9,250, starting April : 6,700 Between 2,762 and 4,466 Baloon Balance (Thousands of Dollars) Quarterly 2,360 - Loan Start Date Final Repayment Date Requirement to Attribute Value of Collateral to Uncleared Balance 78,000 13/01/ /07/ % Financial Covenants Ratio of Value of Collateral to Uncleared Balance as of December % meets financial covenants Ratio of Value of Collateral to Uncleared Balance as of November % meets financial covenants 59,299 23/07/ /07/ /04/ /04/ /05/ /05/ /06/ /06/ **A cross default mechanism exists between the various loans of the same banking institution. b-45

60 EL AL Israel Airlines Ltd. Concise Interim Consolidated Financial Statements As of September (Unaudited)

61 EL AL Israel Airlines Ltd. Consolidated Interim Financial Statements (Unaudited) As of September Table of Contents Page Auditors' reports C - 2 Consolidated Interim Financial Statements (Unaudited): Consolidated Balance Sheets C C - 4 Concise Consolidated Statements of Operations C - 5 Concise Consolidated Statement of Comprehensive Income C - 6 Concise Consolidated Statement of Changes in Shareholders' Equity C C - 11 Concise Consolidated Statements of Cash Flows C C - 13 Notes to the Concise Consolidated Financial Statements C C - 39

62 INDEPENDENT AUDITORS' REPORT TO THE SHAREHOLDERS OF EL AL ISRAEL AIRLINES LTD. Introduction We have reviewed the attached financial information on El Al Israel Airlines Ltd. and its subsidiaries ("the Group"), which includes its concise consolidated balance sheet as of September and its concise consolidated Statement of Operations and Reports on General Earnings, Changes in Equity and Cash Flows for the nine and three month periods ending that date. The Company s Board of Directors and management are responsible for the preparation and presentation of financial information for this interim period in accordance with International Accounting Standard 34 "Interim Financial Reporting", as well as for the preparation of financial information for this interim period in accordance with Chapter D of the Securities Regulations (Periodic and Immediate Reports), We are responsible for expressing our conclusions with regard to the financial information for this interim period, based on our review. We have not reviewed the concise interim financial information for subsidiaries whose assets included in the consolidation account for 1.9% of total consolidated assets as of September 30, 2010, and whose revenues included in the consolidation account for 1.1% and 1.2% of total consolidated revenues for the nine and three-month periods ending that date, respectively. Furthermore, we were presented with the reports of other accountants of an affiliated company the investment in which was $10,285,000 as of September , and the Company s share of its results was $1,199,000 and $319,000 for the nine and three month periods ending that date, respectively. The Financial Statements of said companies have been reviewed by other CPAs, the reports of whom have been provided to us and our conclusion, inasmuch as it refers to financial information pertaining to these companies, is based on the reports by these other CPAs. Scope of the Review We conducted our reviews in accordance with Review Standard 1 of the Israeli Institute of Certified Public Accountants, "Reviews of Financial Information for Interim Periods Prepared by the Entity's Auditor." A review of financial information for interim periods consists of inquiries, mainly from people responsible for finances and accounting, and of the application of analytical and other reviewing procedures. This review is significantly limited in scope compared to audits prepared in accordance with generally accepted Israeli auditing standards and therefore does not allow us to achieve assurance that we have become aware of all material issues that may be identified in an audit. Accordingly, we cannot express an audit-level opinion. Conclusion Based on our reviews and the reports of other CPAs, nothing has come to our attention leading us to believe that the financial information in question has not been prepared, in all material aspects, in accordance with IAS 34. In addition to the above, based upon our review and that of other CPAs, nothing has come to our attention causing us to believe that the financial information in question does not fulfill, in all material aspects, the disclosure directives laid out in Chapter D of the Securities Regulations (Periodic and Immediate Reports), Without detracting from the above conclusion, we direct your attention to Note 1e to the Interim Financial Statements, regarding the plan by Company management to improve its business results and cash flows and Company management is of the opinion that the Company is capable of carrying out its plans. Brightman Almagor Zohar & Co. Certified Public Accountants Tel Aviv, November C -2