20-F 1 zk1312978.htm 20-F zk1312978.htm


SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
 
FORM 20-F
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Date of event requiring this shell company report ____________
 
Commission file number: 0-30198
 
 
INTERNET GOLD – GOLDEN LINES LTD.
(Exact name of Registrant as specified in its charter
and translation of Registrant’s name into English)
 
Israel
(Jurisdiction of incorporation or organization)
 
2 Dov Friedman Street, Ramat Gan 52503, Israel
(Address of principal executive offices)
 
Doron Turgeman, CEO, +972-3-9240000 (phone), +972-3-9399832 (fax)
2 Dov Friedman Street, Ramat Gan 52503, Israel
(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Ordinary Shares, NIS 0.01 Par Value
 
NASDAQ Global Select Market
 
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:
 
Ordinary Shares, par value NIS 0.01 per share …………19,203,186
(as of December 31, 2012)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes o                       No x
 
 
 

 
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
Yes o                        No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x                       No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes o                       No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
U.S. GAAP o
International Financial Reporting Standards as
issued by the International Accounting
Standards Board x
Other o
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:
 
Item 17 o                      Item 18 o
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o                      No x

 
 

 
 
INTRODUCTION
 
We are a leading communications group in Israel. Our shares are listed on the NASDAQ Global Select Market and on the Tel Aviv Stock Exchange, or TASE. Our subsidiaries are B Communications Ltd. (formerly known as 012 Smile.Communications Ltd.) and Goldmind Media Ltd. (formerly known as Smile.Media Ltd.). As used in this annual report, the terms “we,” “us” and “our” mean Internet Gold - Golden Lines Ltd. and its subsidiaries, “B Communications” means B Communications Ltd., “SP1” means B Communications (SP1) Ltd., “SP2” means  B Communications (SP2) Ltd., Goldmind means Goldmind Media Ltd., “Eurocom Communications” means Eurocom Communications Ltd., “Bezeq” means Bezeq - The Israel Telecommunications Corp., Ltd.; “Pelephone” means Pelephone Communications Ltd., “Bezeq International” means Bezeq International Ltd. and “DBS” or “YES” (the trade name for DBS) means DBS Satellite Service (1998) Ltd. Bezeq, Pelephone, Bezeq International and DBS are sometimes referred to as the Bezeq Group in this annual report.
 
On April 14, 2010, our principal subsidiary, B Communications, completed the acquisition of the controlling 30.44% interest in Bezeq (TASE:BZEQ), Israel’s largest telecommunications provider, from Ap.Sb.Ar. Holdings Ltd. (a consortium of Apax Partners, Saban Capital Group and Arkin Communications) for an aggregate cash purchase price of approximately NIS 6.5 billion. In accordance with the terms of the transaction, effective as of the closing of the acquisition, B Communications designated seven directors to replace the Apax-Saban-Arkin Group’s representatives on Bezeq’s Board of Directors, which numbers 13 directors. We began consolidating Bezeq’s financial results into our financial statements effective as of the closing of the acquisition. As of April 22, 2013 B Communications owned 30.97% of Bezeq’s outstanding ordinary shares.
 
Prior to January 2010, B Communications offered a wide range of broadband and traditional voice services in Israel, which we refer to in this annual report as the legacy communications business. As part of its acquisition of the controlling interest in Bezeq, on November 16, 2009, B Communications entered into an agreement to sell its legacy communications business (excluding certain retained indebtedness and liabilities) to a wholly-owned subsidiary of Ampal-American Israel Corporation, or Ampal, for NIS 1.2 billion. The sale of B Communications’ legacy communications business to Ampal was completed on January 31, 2010, and was effective as of January 1, 2010.
 
B Communications changed its name from 012 Smile.Communications Ltd. to B Communications Ltd. on March 16, 2010 in connection with its acquisition of the controlling interest in Bezeq. B Communications’ ordinary shares are listed on the NASDAQ Global Select Market (symbol: BCOM) and on the TASE. We currently own 78.11% of the ordinary shares of B Communications.
 
Effective as of January 1, 2009, we adopted International Financial Reporting Standards, IFRS, as issued by the International Accounting Standards Board, or the IASB, replacing the previous reporting standard which was generally accepted accounting principles in the United States, or U.S. GAAP. Accordingly, beginning January 1, 2009, we have prepared our consolidated financial data according to IFRS as issued by the IASB. Our transition date to IFRS under First Time Adoption of International Financial Reporting Standards was January 1, 2008. Comparative data of our financial statements has been restated to retrospectively reflect the adoption of IFRS. Our consolidated financial statements appearing in this annual report are prepared in New Israeli Shekels and are translated into U.S. dollars at the representative rate of exchange at December 31, 2012 (NIS 3.733 = $1.00). The dollar amounts so presented should not be construed as representing amounts receivable, payable or incurred in dollars or convertible into dollars. All references in this annual report to “dollars” or “$” are to U.S. dollars and all references in this annual report to “NIS” are to New Israeli Shekels.
 
Statements made in this annual report concerning the contents of any contract, agreement or other document are summaries of such contracts, agreements or documents and are not complete descriptions of all of their terms. If we filed any of these documents as an exhibit to this annual report or to any registration statement or annual report that we previously filed, you may read the document itself for a complete description of its terms.
 
 
i

 
 
Forward Looking Statement
 
Except for the historical information contained in this annual report, the statements contained in this annual report are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, as amended, with respect to our business, financial condition and results of operations. Such forward-looking statements reflect our current view with respect to future events and financial results. We urge you to consider that statements which use the terms “anticipate,” “believe,” “do not believe,” “expect,” “plan,” “intend,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements. We remind readers that forward-looking statements are merely predictions and therefore inherently subject to uncertainties and other factors and involve known and unknown risks that could cause the actual results, performance, levels of activity, or our achievements, or industry results, to be materially different from any future results, performance, levels of activity, or our achievements expressed or implied by such forward-looking statements. Such forward-looking statements are also included in Item 4 – “Information on the Company” and Item 5 – “Operating and Financial Review and Prospects.” Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Except as required by applicable law, including the securities laws of the United States, we undertake no obligation to publicly release any update or revision to any forward-looking statements to reflect new information, future events or circumstances, or otherwise after the date hereof. We have attempted to identify significant uncertainties and other factors affecting forward-looking statements in the Risk Factors section that appears in Item 3.D. “Key Information - Risk Factors.
 
 
ii

 
 
TABLE OF CONTENTS
 
Page
 
 
1
1
1
1
A.
Selected Financial Data
1
B.
Capitalization and Indebtedness
2
C.
Reasons for the Offer and Use of Proceeds
2
D.
Risk Factors
2
16
A.
History and Development of the Company
16
B.
Business Overview
19
C.
Organizational Structure
68
D.
Property, Plants and Equipment
69
69
69
A.
Operating Results
69
B.
Liquidity and Capital Resources
82
C.
Research and Development, Patents and Licenses
103
D.
Trend Information
103
E.
Off-Balance Sheet Arrangements
103
F.
Tabular Disclosure of Contractual Obligations
104
104
A.
Directors and Senior Management
104
B.
Compensation
106
C.
Board Practices
106
D.
Employees
111
E.
Share Ownership
112
112
A.
Major Shareholders
112
B.
Related Party Transactions
113
C.
Interests of Experts and Counsel
121
121
A.
Consolidated Statements and Other Financial Information
121
B.
Significant Changes
129
129
A.
Offer and Listing Details
129
B.
Plan of Distribution
130
C.
Markets
130
D.
Selling Shareholders
130
E.
Dilution
130
F.
Expense of the Issue
131
 
 
iii

 
 
131
A.
Share Capital
131
B.
Memorandum and Articles of Association
131
C.
Material Contracts
136
D.
Exchange Controls
136
E.
Taxation
136
F.
Dividends and Paying Agents
142
G.
Statement by Experts
142
H.
Documents on Display
142
I.
Subsidiary Information
143
143
145
 
145
145
145
145
146
146
146
146
147
147
147
147
148
 
148
148
148
148
 
 
iv

 

PART I
 
ITEM 1.                 IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.
 
ITEM 2.                 OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3.                 KEY INFORMATION
 
    A.     Selected Financial Data
 
Effective as of January 1, 2009, we adopted International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or the IASB, replacing the previous reporting standard which was generally accepted accounting principles in the United States, or U.S. GAAP. Accordingly, beginning January 1, 2009, we prepare our consolidated financial data according to IFRS as issued by the IASB. Our transition date to IFRS under First Time Adoption of International Financial Reporting Standards was January 1, 2008.
 
The tables below as of and for the five years ended December 31, 2012 set forth selected consolidated financial data, which is derived from our audited consolidated financial statements. The audited consolidated financial statements as of December 31, 2011 and 2012 and for the years ended December 31, 2010, 2011 and 2012 appear in this annual report.
 
Consolidated Statement of Income Data:
 
 
 
Year Ended December 31,
 
 
 
2008
   
2009
   
2010
   
2011
   
2012
   
2012
 
 
 
(NIS in millions, except share
and per share data)
   
($ in millions, except share and per share data)
 
                                     
Revenues
    1,167       1,243       8,732       11,376       10,278       2,753  
Depreciation and amortization
    117       99       2,295       2,984       2,367       634  
Salaries
    184       171       1,500       2,122       1,986       532  
General and operating expenses
    741       811       3,711       4,468       3,997       1,070  
Other operating expenses
    (6 )     2       (3 )     323       (1 )     -  
      1,037       1,083       7,503       9,897       8,349       2,236  
Operating income
    130       160       1,229       1,479       1,929       517  
Finance expense
    139       134       716       1,077       995       266  
Finance income
    (27 )     (132 )     (327 )     (497 )     (582 )     (156 )
Finance expense, net
    112       2       389       580       413       110  
Income after financing expenses (income), net
    18       158       840       899       1,516       407  
Share of losses in equity-accounted investee
                235       216       245       66  
Income before income tax
    18       158       605       683       1,271       341  
Income tax
    22       58       385       653       555       149  
Net income (loss) for the year
    (4 )     100       220       30       716       192  
Income (loss) attributable to owners of the Company
    (18 )     62       (209 )     (266 )     (38 )     (10 )
Income (loss) attributable to non-controlling interest
    14       38       429       296       754       202  
Net income (loss) for the year
    (4 )     100       220       30       716       192  
Basic earnings (loss) per share.
    (0.85 )     3.39       (11.11 )     (13.56 )     (1.97 )     (0.53 )
Diluted earnings (loss) per share
    (0.89 )     3.39       (11.23 )     (13.60 )     (2.01 )     (0.54 )

 
- 1 -

 
 
 
Statements of Financial Position:
 
 
December 31,
 
 
2008
 
2009
   
2010
   
2011
   
2012
   
2012
 
 
(NIS in millions)
         
($ in millions)
 
                                     
Cash and cash equivalents
    86       1,350       404       1,447       764       205  
Total assets
    1,901       2,846       24,320       25,259       22,804       6,109  
Total current liabilities
    424       1,009       4,305       4,787       4,906       1,314  
Non-current liabilities
    885       1,144       12,304       16,231       14,413       3,861  

Exchange Rate Information
 
The following table sets forth, for the periods and dates indicated, certain information regarding the Bank of Israel representative rate of exchange for dollars, expressed in NIS per one dollar. The representative rate is the average between the buying rate and the selling rate of exchange. We do not use such rates in the preparation of our consolidated financial statements included elsewhere herein. See Note 2 to the consolidated financial statements included elsewhere in this Form 20-F.

Period
 
Average
 
 
 
 
 
 
Year ended December 31, 2008                                                                                                    
 
 
3.586
 
Year ended December 31, 2009                                                                                                    
 
 
3.923
 
Year ended December 31, 2010                                                                                                    
 
 
3.732
 
Year ended December 31, 2011                                                                                                    
 
 
3.579
 
Year ended December 31, 2012                                                                                                    
 
 
3.733
 

Period
 
High
 
 
Low
 
 
 
 
 
 
 
 
 
 
November 2012
 
 
3.952
     
3.810
 
December 2012
 
 
3.835
     
3.726
 
January 2013
 
 
3.791
     
3.714
 
February 2013
 
 
3.733
     
3.663
 
March 2013
 
 
3.733
     
3.637
 
April 2013 (through April 21)
 
 
3.633
     
3.618
 
 
On April 22, 2013, the representative rate of exchange was NIS 3.629= $1.00 as published by the Bank of Israel.
 
        B.       Capitalization and Indebtedness
 
Not applicable.
 
        C.       Reasons for the Offer and Use of Proceeds
 
Not applicable.
 
        D.       Risk Factors
 
Investing in our ordinary shares involves a high degree of risk and uncertainty. You should carefully consider the risks and uncertainties described below before investing in our ordinary shares. If any of the following risks actually occurs, our business, prospects, financial condition and results of operations could be harmed. In that case, the value of our ordinary shares could decline and you could lose all or part of your investment.
 
Risks Related to the Business of Bezeq
 
Bezeq’s competition from other telecommunications providers and recent and potential changes in the competitive environment and communications technologies could adversely affect its business and our results of operations.
 
Competition in the voice, cellular, Internet services and television broadcast markets in Israel is intensifying.  In the last year, competition in the telecommunications industry, particularly in cellular telephony, has intensified with the entry of the new operators, Golan Telecom Ltd., or Golan Telecom, and Hot Mobile Ltd. (previously known as Mirs Communications Ltd.), or Hot Mobile, and with comprehensive service packages and communications packages being offered by our competitors at fixed prices with unlimited use. This has led to lower prices and higher customer churn rates, which in turn has affected the Bezeq Group's results. In an effort to lessen the impact of these developments on their performance, the Bezeq Group companies are taking measures to streamline their operations and improve the services they provide to differentiate themselves from their competitors;  however, there are no assurances that these efforts will be successful.
 
 
- 2 -

 
 
In addition to the entrance of new competitors, competition among the existing communications groups in Israel is intensifying.  Four main groups, consisting of companies under common or joint control, hold a significant amount of the communications market in Israel today: the Bezeq Group, the IDB group, the Partner Communications Company Ltd., or Partner, group, and the HOT Telecom, or HOT, group. This competition can make it difficult for the Bezeq Group to attract new customers and retain existing customers, thereby increasing churn levels. Increased competition, tiered offerings that include lower priced entry level products and special promotions and discounts for customers who subscribe for service packages (packages containing various communications services such as telephony, Internet and broadcast services) from the Bezeq Group may contribute to increased average revenue per unique customer, or ARPU, but would likely reduce the Bezeq Group’s ARPU on a per-service basis for each service included in a package of services.
 
Bezeq expects competition to continue to increase amid the changing legislation in Israel and consolidation in the telecommunications industry. Recently, the availability of service packages has accelerated with the transition to technologies based on IP protocol, which promotes technology convergence between the different communications systems and with the start of penetration of integrated products enabling various communications solutions on the same communications device (e.g. cellular and fixed-line telephony services in one handset).  At present, joint service packages consisting of different communications services of the companies in each communications group are being offered. The marketing of joint service packages enables the communications groups to offer customers packages  that are generally more attractive than individually priced services.  We believe that the Bezeq Group is subject to stricter limitations than those which apply to the other communications groups, including among other things structural separation limitations and a limitation on marketing "joint" service packages.  Also, technological developments and falling equipment prices could enable other operators to provide services similar to those provided by the Bezeq Group at much lower costs.
 
These trends may accelerate at such time as a retail market develops, which will allow mobile virtual network operators, or MVNOs, that do not own infrastructures to offer full end-to-end service bundles (including infrastructure) to their customers.  Following the Israeli government's decision to encourage competition in the cellular market, nine or more MVNO licenses have been granted to date to virtual operators. To the best of our knowledge, only three of the recipients of MVNO licenses currently provide services: Rami Levy Cellular Communications Ltd., or Rami Levy, Alon Cellular Ltd., or Alon Cellular and Home Cellular Ltd.
 
On May 2, 2012, the Ministry of Communications published a policy document with respect to the expansion of competition in the fixed-line communications - wholesale market, which adopted the key recommendations of a committee appointed by the Israeli Ministers of Communications and Finance, or the Hayek Committee, for significant regulatory reforms in the Israeli communications market.  For more information on the regulatory changes see Item 4B “Business Overview” under “Changes in the Regulatory Environment - Competition Policy of the Ministry of Communications.”
 
Fixed-Line Telephony.  Competition in providing fixed-line telephony service is intense, with providers introducing substantial price reductions over the years. We believe that competition in this market will increase due to the low barriers to entry primarily as a result of regulations permitting new service providers who receive a license to provide telephony services using voice over internet protocol, or VoIP, or voice over broadband, or VoB, technology over the infrastructure network owned by either Bezeq or HOT (the end user will still need to purchase access to the infrastructure network directly from Bezeq or HOT).  As a result of the wholesale market implementation, the VoB service providers may be entitled to procure the access to the network infrastructure by itself. The Ministry of Communications requires the various telephony service providers to provide interconnection access in return for payment of an “interconnection fee” set by the Ministry. Competition may also increase following the commencement of operations by the proposed Israeli Electric Corporation, or IEC, joint venture, if successful, and as the result of the policy to develop a wholesale market in telecommunications services.
 
Cellular services have exacerbated the competitive pressures that Bezeq faces as a fixed-line telephony operator. In addition, increasing use of alternative communications technologies may continue to negatively affect Bezeq’s fixed-line call usage volumes and subscriber growth. As new competitors and new technologies enter the market and prices decrease in line with the downward pressure on telephony prices, Bezeq’s fixed-line telephony business may become less profitable and experience a decline in revenues and market share.
 
 Broadband Internet Infrastructure Access.  Bezeq’s principal competitor in high-speed broadband Internet infrastructure access service market is HOT, which is the sole cable operator in Israel.  In addition, Bezeq  faces competition from mobile operators as they are increasingly able to utilize a combination of progressively powerful handsets and high bandwidth technologies, such as universal mobile telecommunications system, or UMTS and, potentially, long-term-evolution, or LTE, technology. Further, the Israeli Ministry of Communications has issued regulatory instructions in an attempt to create a wholesale market for broadband Internet infrastructure access which would allow service providers to provide services to their customers by using Bezeq’s infrastructure.  Competition may also increase following the proposed creation of a public-private joint venture between the government-owned IEC and a private company to be selected in a tender procedure, which, if successful, will use the electric transmission and distribution network in Israel owned by IEC to provide wholesale products to telecommunication services providers, and thus compete with Bezeq and HOT in the wholesale market as well as providing such services directly to large business customers. Bezeq expects competition, including price competition, from HOT, new startups and other companies to increase in the future and we cannot assure you that the joint service packages and other measures that Bezeq has introduced in response to these developments will be successful in attracting and retaining customers.
 
 
- 3 -

 
 
Cellular Services.  The cellular market in Israel is characterized by saturation and a very high penetration level in excess of 100%. Until 2012, four companies operated in Israel's cellular communications market. During 2012, a number of other cellular operators began to operate. The entry of the new operators led to intensified competition, resulting in higher churn rates among the existing operators, a significant decrease in tariffs and consequently a decrease in profits. Pelephone's principal competitors, Cellcom, Partner and Hot Mobile (since February 2012), also provide Internet access services and domestic communications, and they market diverse joint service packages. Pelephone also faces increased competition from Golan Telecom, which launched its services at the same time as HOT Mobile, and MVNOs that provide cellular services under their own brand using the network infrastructure of another service provider. In addition, the Ministry of Communications has granted a special license to a few of the new operators to conduct a marketing experiment that will examine the provision of domestic telephony services using (VoIP over Cellular, or VoC, technology. VoC services may provide an alternative to traditional cellular services or virtual mobile networks, offering an easier and more cost efficient services. If the VoC marketing experiment is successful and the Ministry of Communications grants licenses to offer VoC service, demand for cellular services may be reduced, which would negatively impact revenues and profits from that segment.
 
International telephony. The international telephony market in Israel is characterized by a high degree of competition. At the end of 2012, there were eight companies offering international direct dialing services to private and business customers in Israel. Changes in licensing policy and the expanded use of VoIP technology have significantly reduced the barriers of entry into this market. In addition, during 2012, cellular operators began to offer international direct dial services as part of the unlimited packages they offered.  Bezeq expects competition in this market, including price competition, to increase in the future.
 
Pay Television. The Israeli television market is characterized by a very high penetration rate and an increasing emphasis on new television technology, in particular digital, high-definition, or HD, and interactive television services such as video on demand, or VOD, requiring high-bandwidth and bi-directional distribution platforms. In the multi-channel television market, DBS has only one competitor, HOT. Other factors also have an impact on competition in the market, including the availability of free-to-air digital terrestrial television, or DTT channels and the increasing availability of video content that may be offered through the Internet. In addition, we believe that the implementation of certain regulatory changes may have an impact on competition in the market, including the expansion in the number of free-to-air DTT channels.
 
Competition can make it difficult to attract new customers and retain existing customers, thereby increasing churn levels, and may lead to increased price pressure. There can be no assurance that the Bezeq Group will be able to continue to compete successfully against its current or future competitors in any of its businesses. Bezeq’s failure to do so could have a material adverse effect on its business, financial condition and results of operations.
 
Bezeq operates in a highly regulated telecommunications market which limits its flexibility in managing its business and may materially and adversely affect our results of operations.
 
The Bezeq Group operates in a highly regulated industry in Israel, which limits its flexibility in managing its business efficiently. The Bezeq Group is subject to government supervision and regulation relating to, among other things, its operations, licensing, determining permitted areas of activity, determining tariffs, competition, environmental matters, payment of royalties (zero rate as of 2013), obligation to provide universal service, ability to hold its shares, relationships between Bezeq and its subsidiaries and in certain events, prohibitions against terminating or restricting its services (which may force Bezeq to provide services at a loss).
 
 
- 4 -

 
 
The Ministry of Communications has recently taken active steps to increase competition in the fixed-line and cellular telecommunications industries, including providing licenses to MVNOs and eliminating termination fees that operators can charge, except in limited circumstances, and beginning in January 2013 prohibiting the linkage between the price of services or benefits of the cellular contract and the terms of purchasing handsets. The Ministry of Communications has also introduced a policy for the establishment of a wholesale market for fixed telephony and broadband Internet infrastructure access pursuant to which certain limitations on structural separation and bundling of products may be reduced, but Bezeq would also be required to provide access to its network infrastructure to other service providers on a wholesale basis. The price for such access would be determined based on a commercial agreement between Bezeq and any such service provider, but the Israeli Minister of Communications will be entitled to intervene in the determination of the terms or the price that have been agreed or that is sought by Bezeq if it should find that such price is either unreasonable or could harm the competition, or if the parties have been unable to enter into a commercial agreement. Should the wholesale market develop, certain requirements for structural separation and bundling of products that apply to Bezeq and HOT may be lifted, and thus competition in the broadband Internet infrastructure access market may increase significantly, which could negatively affect Bezeq’s  results of operations.
 
Historically, the Bezeq Group was required to make certain royalty payments to the State of Israel in connection with its broadband and fixed-line services domestic license, DBS’s broadcast license, Pelephone’s cellular license and Bezeq International’s international long distance telephony services. Although these royalty payments decreased in recent years and were reduced to zero in January 2013, there is no assurance that the Ministry of Communications and Ministry of Finance would not reinstate or increase them in the future, which could have a material effect on the Bezeq Group’s results of operations.
 
The pervasive supervision and regulation has at times led to the intervention of the State of Israel. Bezeq’s business and operations could be adversely affected by decisions by regulators, in particular the Ministry of Communications as well as changes in laws, regulations or government policy affecting its business activities. Further risks and uncertainties result from the fact that changes in such laws, regulations or government policies may not be adopted or implemented in the manner that Bezeq expects and may be further amended, interpreted or enforced in an unexpected manner or in a manner adverse to Bezeq’s business and results of operations.
 
Bezeq’s tariffs for its services are subject to government control, which harms its ability to compete and results in an erosion of its tariffs, which adversely affects its business.
 
Bezeq’s tariffs for its services are subject to government control. Some of these tariffs are stipulated in regulations and these regulations also stipulate a formula for updating tariffs. Bezeq is restricted in its ability to give discounts on its principal services and to offer differential tariffs. Further, alternative payment packages, which should provide an immediate alternative to the regulated tariffs, are currently subject to certain conditions which often render the alternative payment package option moot. The foregoing factors harm Bezeq’s ability to compete and results in an erosion of its tariffs, which adversely impacts its business.  Under the policy document that was published by the Ministry of Communications on May 2, 2012, the Ministry has the power to set the price at which Bezeq sells its services to license holders. The application of low prices for such services may adversely affect Bezeq's revenues and profits.
 
Bezeq is subject to restrictions on intercompany relations with affiliated companies, which harms its ability to compete and adversely affects its business.
 
Bezeq’s general license for fixed-line communication services obligates it to ensure that its relationships with its principal subsidiaries do not result in favoring them over their competitors. Bezeq is also subject to various limitations as a result of its declaration as a monopoly in the fixed line services business, as well as limitations set forth in merger approvals granted by the Israeli Antitrust Commission. Separation is required between the managements of Bezeq and its principal subsidiaries, as well as separation between the financial and marketing systems, assets and employees, which result in high administrative overheads. Bezeq is also subject to limitations with respect to the offering of joint service packages with those companies, which adversely impacts its business, particularly in light of the entry into the market of communications companies competing directly with Bezeq in most of its areas of operation based on the provision of bundled services to the customer.
 
Actual and alleged health risks related to cellular network sites and mobile telecommunication devices could have a material adverse effect on Pelephone’s business, operations and financial condition.
 
A number of studies have been conducted to examine the health effects of cellular phone use and network sites, and some of these studies have been construed as indicating that radiation from cellular phone use causes adverse health effects. Media reports have suggested that radio frequency emissions from cellular network sites, cellular handsets and other cellular telecommunication devices may raise various health concerns.  On May 31, 2011, the World Health Organization's International Agency for Research on Cancer (IARC) announced that radiofrequency electromagnetic fields associated with the use of mobile phones may be carcinogenic to humans.
 
Several lawsuits have been filed against cellular operators and other participants in the cellular industry alleging adverse health effects and other claims relating to radio frequency transmissions to and from sites, handsets and other cellular telecommunications devices, including lawsuits against Pelephone, which were settled during 2012 with no material expenses incurred in such settlements.
 
 
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Pelephone takes steps to ensure that the levels of radiation emitted by these transmission facilities, equipment and devices do not exceed the levels of radiation permitted in the directives of the Israeli Ministry of Environment Protection (levels adopted in accordance with international standards). However, health risks may be found to exist and transmission sites or devices and equipment may emit more radiation than that allowed in radiation standards, causing a risk to health, which may have an adverse effect on our business and could result in a reduction in the use of cellular services, difficulty in renting sites, claims for physical and property damages in substantial amounts and attempts to exercise the deeds of indemnity that Pelephone deposited with the planning authorities pursuant to the Planning and Building Law. Pelephone’s third-party liability insurance policy does not currently cover electromagnetic radiation.
 
The Bezeq Group may face difficulties in obtaining some of the building and environmental permits required for the establishment and operation of its network sites, which could have an adverse effect on the coverage, quality and capacity of its network.
 
Bezeq, mainly with respect to its Pelephone cellular operations, is subject to the Israeli Non-Ionizing Radiation Law, 5766-2006, or the Radiation Law, which regulates the emission of electromagnetic radiation from broadcast facilities. The Radiation Law prohibits, among other things, the erection or operation of a source of radiation in contravention of any applicable permit and the erection or operation of a source of radiation without a permit. After receiving a written warning from the authorities, failure to remedy a violation will subject the permit holder to criminal prosecution on a strict liability basis. Pelephone is constantly working to obtain or renew permits to set up and operate its various broadcasting installations; however, the policies maintained by the various relevant entities and amendments to applicable statutes and standards could adversely impact the infrastructure of such installations and the regularity of the services using the infrastructure. As a result, Bezeq’s revenues from these services could be adversely affected.
 
In addition, the establishment and operation of cellular antennas are subject to building permits from various planning and building committees, a process that involves a number of approvals from Israeli state entities and regulatory bodies. The foregoing may impair the quality and capacity of Bezeq’s and Pelephone’s existing networks and the deployment of new networks.
 
To promote compliance Bezeq has established procedures for the erection, operation and measurement of sources of non-ionizing radiation that was approved by its Board of Directors. Bezeq has also assigned an officer to oversee implementation of the compliance procedure. Periodic reports on the status of sources of radiation are submitted to Bezeq’s chief executive officer and to its Board of Directors.
 
Breaches of network or information technology security, natural disasters or terrorist attacks could have an adverse effect on Bezeq’s business.
 
Cyber-attacks or other breaches of network or information technology, or IT, security, natural disasters, terrorist acts or acts of war may cause equipment failures or disrupt Bezeq’s systems and operations.  In particular, both unsuccessful and successful cyber-attacks on companies have increased in frequency, scope and potential harm in recent years.  To date, neither we nor the Bezeq Group have been subject to cyber-attacks or other cyber incidents which, individually or in the aggregate, resulted in a material impact to our operations or financial condition.  However, we expect that Bezeq’s inability to operate its facilities as a result of such events, even for a limited period of time, may result in significant expenses and/or loss of market share to other telecommunications providers.  The potential liabilities associated with these events could exceed the insurance coverage Bezeq maintains.
 
The Bezeq Group accumulates, stores and uses data in the ordinary course of its operations that is protected by data protection laws. Although the Bezeq Group takes precautions to protect subscriber and employee data in accordance with the applicable Israeli privacy requirements, it may fail to do so and certain subscriber and employee data may be leaked or otherwise used inappropriately. Violation of data protection laws may result in fines, loss of reputation and subscriber churn and could have an adverse effect on the Bezeq Group’s business, financial condition and results of operations.
 
Bezeq’s growth prospects depend on a continued demand for fixed-line telephony, Internet, cellular and pay television services.
 
The use of Internet, cellular and pay television services in Israel has increased sharply in recent years making Israel one of the most highly penetrated countries for such services in the world. The Bezeq Group  has benefited from this growth and its growth and profitability depend, in part, on a continued demand for these services and fixed-line telephony services in the coming years. If demand for the Bezeq Group’s current services and products does not increase, its business, financial condition and results of operations could be adversely affected.
 
 
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Bezeq’s systems and operations are vulnerable to damage or interruption, which could expose it to material risk of loss or litigation.
 
Bezeq provides services using various infrastructure systems that include exchanges, transmission, data communication and access systems, cables and computerized systems. Any failure to manage the growth and complexity of Bezeq’s networks could lead to a degradation of service and network disruptions that could harm its reputation and result in a loss of subscribers. If any part of the Bezeq Group’s infrastructure, including its IT systems, becomes subject to a flood, fire, other natural disaster, terrorism, acts of war, a computer virus, a power loss, material bugs in software or other catastrophe or unauthorized access, its operations and customer relations could be materially adversely affected. Although some of Bezeq's systems have backup, damage to some or all of these systems, whether due to a technical fault or natural disaster, could cause extreme difficulties in providing services. If the Bezeq Group were to experience a breakdown of equipment or technology that it cannot timely repair, it might lose subscribers.
 
Pelephone’s operations in the cellular market are exposed to losses in the event of malfunctions in the networks that it operates, terminal equipment that it sells, including various property risks and liabilities. Pelephone’s cellular information systems are networked throughout Israel through designated communications lines and via the Internet, and its cellular business is highly dependent upon these systems. Wide-scale malicious harm or malfunction might adversely affect Pelephone’s cellular business and financial results. Also, Pelephone’s cellular communications network is deployed around the country through network core sites and antenna sites and its cellular business is totally dependent upon these systems. Damage caused by natural or other disasters, war or damage to the switching farm and/or servers used by Pelephone for its core cellular activities could have an adverse effect on its business and results of operations. Pelephone’s cellular business uses two frequency ranges: 850 MHz and 2100 MHz. These frequencies are exposed to interruptions which could impair the service quality of the networks that Pelephone operates.
 
Any catastrophe or other damage that affects the Bezeq Group’s networks could result in substantial uninsured losses. In addition, disaster recovery, security and service continuity protection measures that the Bezeq Group companies have, or may in the future undertake, and their monitoring of network performance, may be insufficient to prevent losses.
 
Additionally, although no incidents have occurred in numbers that are statistically significant, the Bezeq Group’s networks and other technical equipment has been and may continue to be subject to occasional malfunctions due to material bugs in software or technical shortcomings or imperfect interfaces with equipment in private homes, the networks of other operators or its own networks or with other surrounding equipment. The Bezeq Group might incur liabilities or reputational damages as a result of such malfunctions.
 
Pelephone’s assigned frequency may not easily support the implementation of new technologies, which could have an adverse effect on Pelephone’s competitive position in the cellular market.
 
In certain situations the 850/2100 MHz frequencies available to Pelephone may not easily support the implementation of new technologies emerging in the cellular communication sector, which could make it difficult for Pelephone to implement them. This would have an adverse effect on Pelephone's competitive status, since the other licensees have other frequencies available to them, some of which may support those technologies, while obtaining new frequencies may be difficult. Furthermore, Pelephone’s frequencies are exposed to interference and could impair service quality of networks operated by Pelephone. The factors that could cause interference include among other things, the fact that the 850 MHz frequency is also used for terrestrial television broadcasts, and by television stations broadcasting in the Middle East (mainly in Cyprus), which use could cause interference in Pelephone’s networks.
 
Bezeq and its subsidiaries are parties to legal proceedings, which could result in them being ordered to pay significant sums.
 
Bezeq and its subsidiaries are parties to legal proceedings, including class actions, which could result in them being ordered to pay significant sums, the amount of which cannot be estimated. Class action claims can reach large amounts due to the large amount of consumers of Bezeq’s services and a claim that relates to a minor loss for a single consumer can become a material claim for Bezeq if it is certified as a class action applicable to all consumers or a significant portion of them. In addition, since Bezeq provides communications infrastructure as well as billing services to other licensees, parties suing those licensees in other class actions may also try to involve Bezeq as a party to such proceedings.
 
 
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The market in which Bezeq operates is characterized by material capital investments in infrastructure and subscriber equipment and changing technology, which imposes a heavy financial burden on Bezeq and its capital expenditures may not generate a positive return.
 
The market in which Bezeq operates is characterized by material capital investments in infrastructure and subscriber equipment and changing technology. The frequent technological changes in infrastructure and terminal equipment and the intense competition in various market segments impose a heavy financial burden on the companies operating in the market, requiring them to update their infrastructure technology from time to time or to introduce new devices into the market at heavy cost. The development of new technologies can render existing technologies obsolete, resulting in the need for large monetary investments in order to retain a competitive position. Bezeq’s future success will depend on its ability to develop and introduce, on a timely and cost-effective basis, new infrastructure and subscriber equipment that keep pace with technological developments. If Bezeq is unable to respond promptly and effectively to changing technology, it will be unable to compete effectively in the future and its business could be adversely affected.  No assurance can be given that the Bezeq Group’s  recent or future capital expenditures will generate a positive return or that it will have adequate capital available to finance such future upgrades. If the Bezeq Group is unable to, or elects not to, pay for costs associated with expanding or upgrading its networks, or making other capital expenditures, its growth and competitive position could be materially adversely affected.
 
The Bezeq Group’s brands are subject to reputational risks.
 
The Bezeq Group’s brands are well-recognized in Israel. The companies in the Bezeq Group, including Bezeq International, Pelephone and DBS have developed their brands through extensive marketing campaigns, website promotions, customer referrals, and the use of sales forces and dealer networks.  The Bezeq Group’s brands represent a material and valuable asset.
 
Although the Bezeq Group companies try to manage their brands, we cannot guarantee that such brands will not be damaged by circumstances that are outside their control or by third parties with a resulting negative impact on the Bezeq Group’s activities.
 
Bezeq’s results of operations are subject to market risks such as currency fluctuations, inflation in Israel and the general economic environment and financial condition of the capital market in Israel and worldwide.
 
Bezeq’s results of operations are subject to market risks such as currency fluctuations, the general economic environment, inflation in Israel and the financial condition of the capital market in Israel and worldwide. Bezeq measures exposure to changes in exchange rates and inflation by the surplus or deficit of assets against liabilities, based on the type of linkage. In addition, Bezeq is exposed to inflationary changes in Israel as well as to market risks associated with changes to the interest rates relating to its borrowings.
 
Bezeq collects payments from some of its customers in foreign currency, primarily U.S. dollars. In addition, Bezeq consumes services from suppliers outside Israel and pays for these services in foreign currency, primarily U.S. dollars. Changes in the exchange rates of the currencies in which Bezeq operates, primarily the NIS against the U.S. dollar, could have an adverse effect on Bezeq’s cash flow and profitability.
 
Market and financial stability and the strength of the economy in Israel and worldwide have recently been subject to great volatility and led to a global economic slowdown. Although global economic conditions have begun to stabilize or improve, if the local market weakens, Bezeq’s business results could be harmed and its revenues may decrease. Recently, the general economic and capital market conditions in the EMEA region, including Israel, and other parts of the world have undergone significant turmoil. In addition, general market volatility has resulted from uncertainty about sovereign debt and fear that the governments of countries such as Greece, Portugal, Spain, Ireland and Italy may default on their financial obligations. Furthermore, continued hostilities in the Middle East and recent tensions in North Africa could adversely affect the Israeli economy.  If these conditions continue or become worse, Bezeq’s future cost of debt and access to the capital markets could be adversely affected.
 
Negative developments in, or the general weakness of, Israel’s economy, in particular increasing levels of unemployment, may have a direct negative impact on the spending patterns of retail consumers, both in terms of the products they subscribe for and usage levels. Because a substantial portion of our revenue is derived from residential subscribers who may be impacted by these conditions, it may be (i) more difficult to attract new subscribers, (ii) more likely that certain of our subscribers will downgrade or disconnect their services and (iii) more difficult to maintain ARPUs at existing levels. In addition, we can provide no assurances that a deterioration of the economy will not lead to a higher number of non-paying customers or generally result in service disconnections. Therefore, a weak economy and negative economic development may jeopardize our growth targets and may have a material adverse effect on Bezeq’s business, financial condition and results of operations.
 
 
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A significant portion of Bezeq Group’s workforce is represented by labor unions, and the companies in the Bezeq Group could incur additional costs or experience work stoppages as a result of the negotiation of their labor contracts or organizing activities.
 
As of December 31, 2012, a significant portion of the employees of the Bezeq Group is represented by the New General Federation of Workers, or the Histadrut.  In December 2006, a special collective agreement was signed between Bezeq, its workers’ representatives and the Histadrut, regulating the labor relations in Bezeq following its privatization. 
 
Pelephone received a notice from the Histadrut in September 2012, that it constitutes a representative workers union of Pelephone employees.  On November 26, 2012, Pelephone received a notice from the Histadrut of a strike beginning December 10, 2012, due to its alleged failure to recognize the Histadrut as a representative organization and its refusal to conduct negotiations on a collective agreement, as well as wage-related demands and employee dismissal issues.  On January 7, 2013, Pelephone notified the Histadrut that it recognized it as the representative organization for Pelephone and the parties began to negotiate a collective labor agreement. The negotiating process may cause labor unrest and harm Pelephone's on-going activity. The collective labor agreement may limit management flexibility and impose additional costs on Pelephone.
 
The Bezeq Group depends on hardware, software and other providers of outsourced services, who may discontinue their services or products, seek to charge prices that are not competitive or choose not to renew their contracts.
 
The Bezeq Group has important relationships with several suppliers of hardware, software and related services that are used to operate its businesses. In certain cases,  substantial investments have been made in the equipment or software of a particular supplier, making it difficult to quickly change supply and maintenance relationships in the event that the initial supplier refuses to offer favorable prices or ceases to produce equipment or provide the support that the Bezeq Group requires. Further, in the event that hardware or software products or related services are defective, it may be difficult or impossible to enforce recourse claims against suppliers, especially if warranties included in contracts with suppliers have expired or are exceeded by those in Bezeq’s contracts with its subscribers, in individual cases, or if the suppliers are insolvent, in whole or in part. In addition, there can be no assurances that the Bezeq Group will be able to obtain the hardware, software and services it needs for the operation of its business, in a timely manner, at competitive terms and in adequate amounts.
 
The Bezeq Group’s ability to renew its existing contracts with suppliers of products or services, or enter in to new contractual relationships, upon the expiration of such contracts, either on commercially attractive terms, or at all, depends on a range of commercial and operational factors and events, which may be beyond its control. The occurrence of any of these risks could create technical problems, damage the Bezeq Group’s reputation, result in the loss of customer relationships and have a material adverse effect on its business, financial condition and results of operations.
 
The Bezeq Group may be subject to claims of intellectual property infringement, which could have an adverse impact on its businesses or operating results.
 
The Bezeq Group is subject to the risk of intellectual property rights claims against it. The Bezeq Group has and may receive in the future claims of infringement or misappropriation of other parties’ proprietary rights, particularly creative rights with respect to DBS’s broadcasted programs or Pelephone's music streaming. In addition to claims relating to broadcasts on channels DBS owns, it may be subject to intellectual property infringement claims with respect to programs broadcast on foreign channels that it carries. Successful challenges to DBS’s rights to intellectual property could require DBS to enter into royalty or licensing agreements on unfavorable terms, incur substantial monetary liability or be enjoined preliminarily or permanently from further use of the intellectual property in question. This could require a change in business practices and limit the ability to provide customers with the content that they expect. If DBS is required to take any of these actions, it could have an adverse impact on its businesses or operating results.
 
Even if the claims of intellectual property infringement are without merit, defending against the claims can be time-consuming and costly and divert management’s attention and resources away from its businesses. Israeli law relating to intellectual property contains provisions allowing the owner of an intellectual property right to apply the Israeli courts to grant various enforcement measures and other remedies, such as temporary and permanent injunctive relief, a right to confiscate infringing goods and damages. If any of these claims succeed, the Bezeq Group  may be forced to pay damages or may be required to obtain licenses for the infringing product or service and may incur liabilities or reputational damages as a result thereof. If the Bezeq Group cannot obtain all necessary licenses on commercially reasonable terms, it may be forced to stop using or selling the products and services, which could adversely affect its ability to provide certain services and products.
 
 
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Operating in the Israeli domestic fixed-line communications segment has major entry and exit barriers.
 
Operating in the domestic fixed-line communications segment requires receipt of the appropriate domestic carrier licenses. Traditionally, the main entry barrier to this segment arose from the need for heavy investment in technological infrastructure and in surrounding systems until obtaining economies of scale, and from high costs involving the establishment of marketing, sales, collection and customer support systems and the building of a brand. In recent years, these traditional entry barriers to Bezeq's segments of operation have lessened considerably as a result of the following factors: technological improvements, lower infrastructure and equipment prices, easing of regulation granted to new competitors, the mandatory obligation to allow the use of Bezeq’s (and Hot’s) infrastructures and services, and the ability to use existing networks, including Bezeq's network, by competing communications carriers or those destined to compete with Bezeq.
 
The regulation of competition in VoB-based telephony, which enables telephony services to be provided based on a broadband infrastructure of another operator without need for an independent line telephony infrastructure (and in the future, if it becomes possible, competition based on dividing the network into sections and wholesale sale of services), significantly reduces the size of investment required from those competing with Bezeq, thereby making entry barriers to the segment much lower.
 
The main exit barriers relate to the commitment of Bezeq incorporated in its license to provide its services universally (to the entire public in Israel) and to a defined quality, its subordination to the provisions of the Communications Order (Determination of Essential Service Provided by “Bezeq” The Israel Telecommunication Corp. Limited), 5757-1997, or the Communications Order, the regulations accompanying the Israeli Communications Law (Telecommunications and Broadcasting), 1982 or the Communications Law, the provisions  of Section 13A of the Communications Law relating to emergency operation, Bezeq’s commitment to those of its employees who are employed under collective agreements, long-term agreements with infrastructure suppliers, the large investments requiring the passage of time before seeing a return and Bezeq’s commitment to the repayment of long-term loans taken to finance the investments.
 
If DBS is unable to obtain attractive programming on satisfactory terms for its pay television services, the demand for these services could be reduced, thereby lowering revenue and profitability.
 
The success of DBS’s services depends on access to an attractive selection of television programming from content providers. The ability to provide movie, sports and other programming, including VOD content, is a major factor that attracts subscribers to pay television services, especially premium services.
 
DBS relies on digital programming suppliers for a significant portion of its programming content and VOD services.  It may not be able to obtain sufficient high-quality programming from third-party producers for our digital cable television services on satisfactory terms or at all in order to offer compelling digital cable television services. Further, there can be no assurance that the local content that DBS provides will continue to be successful. The inability to obtain high-quality content may also limit DBS’s ability to migrate customers from lower priced packages to higher tier programming, thereby inhibiting its ability to execute its business strategy. Any or all of these factors could result in reduced demand for, and lower revenue and profitability from, DBS’s satellite broadcast services.
 
Risks Related to Our Company
 
We and B Communications have a substantial amount of debt, which could restrict our financing and operating flexibility and have other adverse consequences; our ability to repay our debt may be affected by Bezeq’s distribution policy and the amount of dividends we receive from Bezeq.
 
To facilitate the funding of its acquisition of the controlling interest in Bezeq, B Communications entered into two financing agreements under which it received loans in a total principal amount of NIS 5.1 billion, of which NIS 2.6 billion (approximately $0.7 billion) was outstanding at December 31, 2012. As of April 22, 2013, the financing agreements include certain financial covenants, including, among other things, the requirement that Bezeq maintain certain minimum shareholders equity and minimum ratio of shareholders’ equity. In addition, B Communications’ wholly-owned subsidiary that directly holds the Bezeq interest must maintain a minimum ratio of debt to EBITDA and a debt service coverage ratio. The Bezeq shares that were acquired and all of the rights and assets  of such subsidiary (except for 29,662,168 ordinary shares of Bezeq that were acquired in 2011 and such additional Bezeq shares that may be acquired in the future)  have been pledged to the lenders as security under the loan agreements. In addition, B Communications has pledged the entire equity of the subsidiary established to acquire the Bezeq shares. Our ability to repay our debt and B Communications’ ability to repay its debt may be affected by Bezeq’s distribution policy and the amount of dividends received from Bezeq. If we and B Communications are unable to meet our debt obligations or comply with our debt covenants, we could be forced to renegotiate or refinance our indebtedness, seek additional equity capital or sell assets. We may be unable to obtain financing or sell assets on satisfactory terms, or at all. For more information regarding our debt instruments and our consolidated indebtedness, see Item 5.B “Operating and Financial Review and Prospects - Liquidity and Capital Resources.”
 
 
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Our operating results may be adversely affected by significant fluctuations in the Israeli consumer price index and in interest rates.
 
As the principal amount of, and interest that we pay on, certain of our debentures and a significant portion of our bank loans are linked to the Israeli Consumer Price Index, or CPI, or are subject to variable interest rate, any increase in the Israeli CPI or in the interest rate will increase our financial expenses and could adversely affect our results. In addition, Bezeq’s tariff updating mechanism, which is subject to government regulation, is reviewed once a year and is influenced by the CPI. As a result, the annual rate of inflation and its distribution during the year can have a material influence on the erosion of Bezeq’s tariffs and its revenues and expenses during the year.
 
Our exposure to market risk for changes in interest rates also relates to our investment in marketable securities. Investments in both fixed rate and floating rate interest bearing securities carry a degree of interest rate risk. The market pricing for such fixed rate securities may be adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Due in part to these factors, our future financial results may be negatively affected in the event that interest rates fluctuate.
 
We, B Communications and other members of the Eurocom group are subject to a control permit for holding the controlling interest in Bezeq.  Failure to comply with this permit or other regulatory provisions relating to the control of Bezeq may result in the revocation of the control permit and our rights with respect to our Bezeq interest would be adversely impacted, which would materially and adversely affect our business and financial position.
 
As part of the acquisition of the controlling interest in Bezeq, we, B Communications, B Communications (SP2) Ltd., or SP2, B Communications (SP1) Ltd., or SP1 and other members of the Eurocom group were granted a permit to control Bezeq, pursuant to the Communications Law and the Communications Order. The control permit includes several conditions, including, among others, the requirement that SP2 be controlled exclusively by the other parties to the control permit and that the parties to the control permit hold not less than 30% of any type of means of control of Bezeq and SP2. In February 2011, Israel’s Prime Minister and Minister of Communications, or the Ministers, permitted such percentage to decrease to 29% for a period of six months commencing from the date such holdings fall below 30%, in the event of dilution resulting from the exercise of stock options by Bezeq employees.  In addition, the control permit requires that a certain percentage of SP2 be held at all times by an “Israeli Party,” as defined in the Communications Order. The control permit also includes certain notice requirements regarding changes in the composition of the board of directors and certain holdings in us and B Communications. If we, B Communications or any other member of the Eurocom group subject to the control permit fails to comply with the terms of the control permit or with other regulatory provisions relating to the control of Bezeq, such permit could be revoked and our rights with respect to our Bezeq interest would be adversely impacted, which would have a material adverse effect on our business and financial position.
 
If we do not maintain control of Bezeq we may be deemed to be an “investment company” under the Investment Company Act of 1940, which could materially and adversely affect our business.
 
Section 3(a)(1)(A) of the Investment Company Act of 1940, or the Investment Company Act, defines an investment company as any issuer that is, holds itself out as being, or proposes to be, primarily engaged in the business of investing, reinvesting or trading in securities and Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” (within the meaning of the Investment Company Act) having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. However, an issuer will be deemed not to be an investment company if no more than 45% of the value of such issuer’s total assets (exclusive of government securities and cash items) consists of, and no more than 45% of such issuer’s net income after taxes (for the last four fiscal quarters combined) is derived from, securities other than, among other things, securities issued by companies which are controlled primarily by such issuer. Primary control is presumed if the issuer owns over 25% of the controlled company’s voting securities and the issuer has control greater than that of any other person. Accordingly, so long as we maintain control of Bezeq, we will not be deemed an investment company.
 
If we were to no longer maintain the control of Bezeq, we could, among other things, be required either (i) to change substantially the manner in which we conduct our operations to avoid being subject to the Investment Company Act or (ii) to register as an investment company. An investment company that is organized under the laws of a foreign country may not register as an investment company, or publicly offer its securities through interstate commerce in the United States, unless the company applies to the Securities and Exchange Commission, or the SEC, for an order permitting the company to register under the Investment Company Act, and to make a public offering in the United States. The SEC may issue an order granting the application if it finds that, by reason of special circumstances or arrangements, it is both legally and practically feasible effectively to enforce the provisions of the Investment Company Act against the issuer, and further finds that granting the application is otherwise consistent with the public interest and the protection of investors.
 
 
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If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with certain affiliates, reporting, record keeping, voting, proxy and disclosure requirements, and meeting these requirements would be costly, if at all possible.
 
We may fail to maintain effective internal control over our financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, which could have an adverse effect on our financial results and the market price of our ordinary shares.
 
Section 404 of the Sarbanes-Oxley Act requires any company subject to the reporting requirements of the U.S. securities laws to do a comprehensive evaluation of its and its combined subsidiaries’ internal control over financial reporting. To comply with this statute, we are required to document and test our internal control over financial reporting, and our management is required to assess and issue a report concerning our internal control over financial reporting. The rules governing the standards that must be met for management to assess our internal control over financial reporting are relatively new and complex and require significant documentation, testing and possible remediation to meet the detailed standards under the rules.
 
Beginning in the 2010 second quarter, we began consolidating Bezeq’s financials results into our financial statements following our acquisition of the controlling interest in Bezeq. Commencing with our management report on internal control over financial reporting for the year ended December 31, 2011, our management report on internal control over financial reporting must include an assessment with of Bezeq’s internal control over financial reporting. Prior to our acquisition of the controlling interest, Bezeq was not subject to Section 404 of the Sarbanes-Oxley Act. We may in the future identify a material weakness in Bezeq’s internal control over financial reporting. Failure to maintain effective internal control over financial reporting could result in investigation or sanctions by regulatory authorities and could have a material adverse effect on our operating results, investor confidence in our reported financial information and the market price of our ordinary shares.
 
Risks Related to Our Relationship with Eurocom Communications Ltd.
 
Because Eurocom Communications controls substantially all the voting power of our ordinary shares, investors will not be able to affect the outcome of all shareholder votes.
 
Eurocom Communications beneficially owned 78.97% of our outstanding ordinary shares, as of April 22, 2013.  For as long as Eurocom Communications has a controlling interest in our company, it, Mr. Shaul Elovitch, the chairman of our board of directors and the chairman of the board of directors of Eurocom Communications, and the controlling shareholder of Eurocom Communications will have the power to determine or significantly influence the outcome of matters submitted to a vote of our shareholders that require a simple majority, including the power to elect all of the members of our board of directors (except outside directors, within the meaning of Israeli law) and will have the ability to exercise a controlling influence over our business and affairs, including any determinations with respect to potential mergers or other business combinations involving us, our acquisition or disposition of assets, our incurrence of indebtedness, our issuance of any additional ordinary shares or other equity securities, our repurchase or redemption of ordinary shares and our payment of dividends. Because the interests of Eurocom Communications and Mr. Elovitch may differ from the interests of our other shareholders, actions taken by Eurocom Communications with respect to us may not be favorable to our other shareholders.
 
Conflicts of interest may arise between Eurocom Communications, B Communications, other companies within the Eurocom group and us that could be resolved in a manner unfavorable to us and result in reduced revenues and income.
 
Conflicts of interest may arise between B Communications, Eurocom Communications and us in a number of areas relating to our past and ongoing relationships. Areas in which conflicts of interest between B Communications, Eurocom Communications and us could arise include, but are not limited to, the following:
 
 
·
Cross officerships, directorships and share ownership. The ownership interests of our directors in our ordinary shares could create, or appear to create, conflicts of interest when directors and executive officers are faced with decisions that could have different implications for the two companies. For example, these decisions could relate to the nature, quality and cost of services rendered to us by Eurocom Communications and B Communications, disagreements over the desirability of a potential acquisition opportunity or employee retention or recruiting. In addition, Eurocom Communications may take an opportunity for itself or preclude us from taking advantage of a corporate opportunity; and
 
 
- 12 -

 
 
 
·
Intercompany transactions. From time to time, Eurocom Communications, B Communications or other companies within the Eurocom group may enter into transactions with us or our subsidiaries or other affiliates. Although the terms of any such transactions will be established based upon negotiations between employees of such companies and us and, when appropriate, subject to the approval of our independent directors or a committee of disinterested directors and in some instances a vote of shareholders, the terms of any such transactions may not be as favorable to us or our subsidiaries or affiliates as may otherwise be obtained in arm’s-length negotiations with unaffiliated third parties. For more information about intercompany transactions, see Item 7B. “Major Shareholders and Related Party Transactions - Related Party Transactions.
 
Risks Related to Our Ordinary Shares
 
Our share price has been volatile and may decrease  in the future.
 
The market price of our ordinary shares has been subject to significant price movements and could be subject to wide fluctuations in the future in response to factors such as the following, some of which are beyond our control:
 
 
·
Quarterly variations in our operating results;
 
 
·
Global economic conditions;
 
 
·
Price movements in the market price of B Communications’ and Bezeq’s ordinary shares;
 
 
·
Operating results that vary from the expectations of securities analysts and investors;
 
 
·
Changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors;
 
 
·
Regulatory changes that impact pricing of services and competition in Bezeq’s markets;
 
 
·
Changes in market valuations of other communications companies;
 
 
·
Announcements of technological innovations or new services by Bezeq or its competitors;
 
 
·
Announcements by Bezeq or its competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
 
·
Changes in the status of Bezeq’s intellectual property rights;
 
 
·
Announcements by third parties of significant claims or proceedings against us or Bezeq;
 
 
·
Additions or departures of key personnel;
 
 
·
Future sales of our ordinary shares; and
 
 
·
Stock market price and volume fluctuations.
 
Domestic and international stock markets often experience extreme price and volume fluctuations. Market fluctuations, as well as general political and economic conditions, such as a recession or interest rate or currency rate fluctuations or political events or hostilities in or surrounding Israel, could adversely affect the market price of our ordinary shares.
 
We have never paid cash dividends to our shareholders and have not adopted a dividend distribution policy.
 
We have never declared or paid cash dividends on our ordinary shares and have not adopted a dividend distribution policy. B Communications’ indirect wholly-owned subsidiary, SP2, which directly holds Bezeq’s shares and our principal source of revenues and income, is subject to limitations on the payment of dividends under the terms of the financing agreements entered into in connection with its acquisition of the controlling interest in Bezeq. You should not rely on an investment in our company if you require dividend income from your investments.
 
We may in the future be classified as a passive foreign investment company, which will subject our U.S. investors to adverse tax rules.
 
We may be treated in the future as a “passive foreign investment company,.” which could result in a reduction in the after-tax return to the U.S. holders of our ordinary shares and may cause a reduction in the value of such shares. A foreign corporation will be treated as a passive foreign investment company for U.S. federal income tax purposes if either (1) at least 75% of its gross income for any taxable year consists of certain types of “passive income,” or (2) at least 50% of the average value of the corporation’s gross assets produce, or are held for the production of, such types of “passive income.” For purposes of these tests, “passive income” includes dividends, interest and gains from the sale or exchange of investment property; and cash is considered to be an asset that produces passive income. If we are classified in the future as a passive foreign investment company for U.S. federal income tax purposes, highly complex rules would apply to U.S. shareholders owning ordinary shares. Accordingly, you are urged to consult your tax advisors regarding the application of such rules. United States residents should carefully read “Item 10E. Additional Information - Taxation, United States Federal Income Tax Consequences” for a more complete discussion of the U.S. federal income tax risks related to owning and disposing of our ordinary shares.
 
 
- 13 -

 
 
Risks Related to the Operations of Bezeq and Our Company in Israel
 
Political, economic and military instability in Israel may disrupt our operations and negatively affect our business condition, harm our results of operations and adversely affect our share price.
 
We and Bezeq are incorporated and based in the State of Israel and Bezeq derives substantially all of its revenues from markets within the State of Israel. As a result, political, economic and military conditions affecting Israel directly influence us. Any major hostilities involving Israel, a full or partial mobilization of the reserve forces of the Israeli army, the interruption or curtailment of trade between Israel and its present trading partners, or a significant downturn in the economic or financial condition of Israel could adversely affect our business, financial condition and results of operations.
 
Since its establishment in 1948, Israel has been involved in a number of armed conflicts with its Arab neighbors and a state of hostility, varying from time to time in intensity and degree, has continued into 2013. In recent years, there was an escalation in violence among Israel, Hamas, the Palestinian Authority and other groups. Also, since 2011, riots and uprisings in several countries in the Middle East and neighboring regions have led to severe political instability in several neighboring states and to a decline in the regional security situation. Such instability may affect the local and global economy, could negatively affect business conditions and, therefore, could adversely affect our operations. In addition, Iran has threatened to attack Israel and is widely believed to be developing nuclear weapons. Iran is also believed to have a strong influence among extremist groups in areas that neighbor Israel, such as Hamas in Gaza and Hezbollah in Lebanon.
 
To date, these matters have not had any material effect on our business and results of operations; however, the regional security situation and worldwide perceptions of it are outside our control and there can be no assurance that these matters will not negatively affect us in the future. Ongoing violence between Israel and the Palestinians as well as tension between Israel and other countries in the Middle East may materially affect our business, financial condition and results of operations.
 
Our results of operations may be negatively affected by the obligation of our personnel to perform military service.
 
Many of Bezeq’s and our executive officers and employees in Israel are obligated to perform annual reserve duty in the Israeli Defense Forces and may be called for active duty under emergency circumstances at any time. If a military conflict or war arises, these individuals could be required to serve in the military for extended periods of time. Bezeq’s operations could be disrupted by the absence for a significant period of one or more of its executive officers or key employees or a significant number of other employees due to military service. Any disruption in Bezeq’s operations could adversely affect its business.
 
Bezeq may be restricted in the conduct of its operations during periods of national emergency, which could negatively affect its business operations.
 
During periods of national emergency, the Minister of Communications and other governmental authorities may issue various instructions regarding the use of Bezeq’s network, including the use of the network by the Israeli security forces. In addition, the Israeli Equipment Registration and IDF Mobilization Law, 1987 permits the registration, taking and use of engineering equipment and facilities by Israel’s Defense Forces. These actions could adversely affect Bezeq’s business operations.
 
Our operating results may be adversely affected by significant fluctuations of the NIS against foreign currencies.
 
We report our financial results in NIS. Bezeq receives payments in NIS for most of its sales. As a result, fluctuations in rates of exchange between NIS and the U.S. dollar may affect our operating results and financial condition. In addition, when the Israeli inflation rate exceeds the rate of the NIS depreciation against foreign currencies, some of our NIS expenses increase to the extent of the difference between the rates. A significant disparity of this kind may have a material adverse effect on our operating results.
 
 
- 14 -

 
 
From time to time, the Bezeq Group engages in currency hedging transactions to reduce the impact on its cash flows and results of operations of currency fluctuations. The Bezeq Group recognizes freestanding derivative financial instruments as either assets or liabilities in the statements of financial position and it measures those instruments at fair value. However, accounting for changes in the fair value of a derivative instrument, such as a currency hedging instrument, depends on the intended use of the derivative instrument and the resulting designation. For derivative instruments that are not designated as cash flow hedges, changes in fair value are recognized in our income statement without any reference to the change in value of the related budgeted expenditures. These differences could result in fluctuations in our reported net income on a quarterly basis.
 
As a foreign private issuer whose shares are listed on the NASDAQ Global Select Market, we may follow certain home country corporate governance practices instead of certain NASDAQ requirements.
 
As a foreign private issuer whose shares are listed on the NASDAQ Global Select Market, we are permitted to follow certain home country corporate governance practices instead of certain requirements of the NASDAQ Stock Market Rules. As a foreign private issuer listed on the NASDAQ Global Select Market, we may follow home country practice with regard to, among other things, the composition of the board of directors, compensation of officers, director nomination process and quorum at shareholders’ meetings. In addition, we may follow home country practice instead of the NASDAQ requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, an issuance that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company). A foreign private issuer that elects to follow a home country practice instead of NASDAQ requirements must submit to NASDAQ in advance a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws. In addition, a foreign private issuer must disclose in its annual reports filed with the SEC each such requirement that it does not follow and describe the home country practice followed by the issuer instead of any such requirement. Accordingly, our shareholders may not be afforded the same protection as provided under NASDAQ’s corporate governance rules.
 
Our shareholders generally may have difficulties enforcing a U.S. judgment against us, our executive officers and directors and some of the experts named in this annual report, or asserting U.S. securities law claims in Israel.
 
We are incorporated in Israel and all of our executive officers and directors named in this annual report reside outside the United States. Service of process upon them may be difficult to effect within the United States. Furthermore, all of our assets and most of the assets of our executive officers and directors and some of the experts named in this annual report are located outside the United States. Therefore, a judgment obtained against us or any of them in the United States, including one based on the civil liability provisions of the U.S. federal securities laws may not be collectible in the United States and may not be enforced by an Israeli court. It also may be difficult for you to assert U.S. securities law claims in original actions instituted in Israel.
 
Provisions of Israeli law, the licenses of Bezeq and our articles of association may delay, prevent or make difficult an acquisition of our company, which could prevent a change of control and, therefore, depress the price of our shares.
 
Following our acquisition of the controlling interest in Bezeq, we and our shareholders are required to comply with the Communications Law, the Communications Order and regulations promulgated by the Ministry of Communications.
 
Pursuant to the Communications Order, we were required to obtain the prior written consent of the Ministers in order to acquire the controlling interest in Bezeq. Under the Communications Order, no person may hold, directly or indirectly, “significant influence” over Bezeq or 5% or more of any particular class of means of control in Bezeq, nor may any person, together with any other person, appoint, elect or dismiss the general manager of Bezeq or cause the election, appointment or dismissal of any director of Bezeq, without the prior written consent of the Ministers. Subject to certain exceptions, prior written approval of the Ministers is also required to increase the holdings or other rights in excess of those determined in the initial approval, including by means of an agreement (including a voting agreement). Furthermore, under the Communications Order, no person may transfer control, “significant influence” or means of control in Bezeq to another, if, as a result of the transfer, the holdings of the transferee would require approval pursuant to the Communications Law or Communications Order and the transferee is not in possession of the requisite approval. For the foregoing purposes, “significant influence” means the ability to significantly influence the activity of a corporation, whether alone or together with or through others, directly or indirectly, other than as a result of holding “means of control” in that corporation or in another corporation, and including ability derived from the corporation’s articles of association, a written, oral or other kind of agreement, or from any other source. In this context, the right to appoint an office holder holding 25% of our means of control is presumed to confer significant influence. “Means of control” means the right to vote at a general meeting of the company, to appoint a director or general manager of the company, to participate in the profits of the company or a share of the remaining assets of the company after payment of its debts upon liquidation.
 
 
- 15 -

 
 
Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to these types of transactions. Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to some of our shareholders, including Israeli shareholders and shareholders whose country of residence does not have a tax treaty with Israel exempting such shareholders from Israeli tax. For example, Israeli tax law does not recognize tax-free share exchanges to the same extent as U.S. tax law. With respect to mergers, Israeli tax law allows for tax deferral in certain circumstances but makes the deferral contingent on the fulfillment of numerous conditions, including a holding period of two years from the date of the transaction during which sales and dispositions of shares of the participating companies are limited. Moreover, with respect to certain listed share swap transactions, the tax deferral is limited in time, and when the time expires, tax then becomes payable even if no actual disposition of the shares has occurred. These provisions of Israeli law may delay, prevent or make difficult an acquisition of our company, which could prevent a change of control and therefore depress the price of our shares. For additional discussion about some anti-takeover effects of Israeli law, see Item 10B. “Additional Information - Memorandum and Articles of Association” and Item 10E. “Taxation -Israeli Tax Considerations.”
 
The rights and responsibilities of our shareholders are governed by Israeli law and differ in some respects from those under Delaware law.
 
Because we are an Israeli company, the rights and responsibilities of our shareholders are governed by our articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in a Delaware corporation. In particular, a shareholder of an Israeli company has a duty to act in good faith towards the company and other shareholders and to refrain from abusing his, her or its power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. Israeli law provides that these duties are applicable to shareholder votes on, among other things, amendments to a company’s articles of association, increases in a company’s authorized share capital, mergers and interested party transactions requiring shareholder approval. In addition, a shareholder who knows that it possesses the power to determine the outcome of a shareholders’ vote or to appoint or prevent the appointment of a director or executive officer of the company has a duty of fairness towards the company. However, Israeli law does not define the substance of this duty of fairness. There is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.
 
ITEM 4.                 INFORMATION ON THE COMPANY
 
A.           History and Development of the Company
 
We were incorporated under the laws of the State of Israel in April 1992 under the name Euronet Golden Lines (1992) Ltd. In June 1999 we changed our name to Internet Gold - Golden Lines Ltd. We are a public limited liability company under the Israeli Companies Law 1999 and our shares are traded on the NASDAQ Global Select Market and TASE. Our registered offices and principal place of business are located at 2 Dov Friedman Street, Ramat Gan 52503, Israel, and our telephone number is +972-72-924-0000. Our address on the Internet is www.igld.com.The information on our website is not incorporated by reference into this annual report on Form 20-F.
 
We are a leading communications group in Israel. Our principal subsidiary, B Communications, is the controlling shareholder of Bezeq (TASE: BZEQ), Israel’s largest telecommunications provider. Since B Communications’ initial public offering in October 2007, its ordinary shares have been listed on the NASDAQ Stock Market (symbol: BCOM) and the TASE, and since January 1, 2011 its ordinary shares are listed on the NASDAQ Global Select Market. We currently own 79.94% of the ordinary shares of B Communications. B Communications maintains a website at www.bcommunications.co.il . The information on B Communications’ website is not incorporated by reference into this annual report on Form 20-F.
 
We began providing Internet access services in 1996, and began offering broadband services in 2001 and traditional voice services in 2004.  As part of our internal restructuring in 2006, we transferred our broadband and traditional voice services businesses, which we refer to in this annual report as the legacy communications business, to B Communications (formerly named 012 Smile. Communications), and our media operations to Goldmind Ltd. (formerly named 012 Smile.Media). During 2010 and 2011 we sold all of our media assets.
 
 
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Acquisition of the Controlling Interest in Bezeq
 
On April 14, 2010, B Communications completed the acquisition of 30.44% of Bezeq’s outstanding shares from Ap.Sb.Ar. Holdings Ltd. for a purchase price of approximately NIS 6.5 billion in cash and became the controlling shareholder of Bezeq. The Bezeq interest was directly acquired by an indirect wholly-owned subsidiary of B Communications.  In accordance with the terms of the transaction, effective as of the closing of the acquisition, we designated seven directors to replace the Apax-Saban-Arkin Group’s representatives on Bezeq’s 13 person Board of Directors. We began consolidating Bezeq’s financial results into our financial statements effective as of the closing of the acquisition and began reporting the consolidated results in our 2010 second quarter earnings release. As of April 22, 2013, B Communications holds a 30.97% ownership interest of Bezeq.
 
Bezeq is the principal provider of communications services in Israel. Bezeq and its subsidiaries implement and provide a broad range of telecommunications operations and services, including domestic fixed-line, cellular, Internet services, international communication services, multi-channel television, satellite broadcasts, customer call centers, maintenance and development of communications infrastructures, provision of communications services to other communications providers, television and radio broadcasts, and supply and maintenance of equipment on customer premises (such as network endpoint services). Bezeq, which was established as a government company in 1980, became a public company in 1990 and its shares are traded on the TASE and included in the TA-25 Index.
 
Below are details of the ownership interest in Bezeq at December 31, 2012 and at March 31, 2013, and on a fully diluted basis at April 22, 2013, assuming the exercise of all options granted to employees and managers of the Bezeq Group at April 22, 2013.
 
   
On an outstanding basis
   
With full dilution
 
Shareholders
 
At
December 31, 2012
   
At
March
31, 2013
   
at April 22,
2013 (1)
 
                         
B Communications (2)
   
30.97
%
   
30.97
%
   
30.19
%
Public
   
69.03
%
   
 69.03
%
   
69.81
%


 
(1)
Full dilution calculation assumes that all outstanding options are exercised pursuant to the Stock Appreciation Rights (SAR) mechanism of the 2007 Stock Option Plan for Managers and Senior Employees in the Bezeq Group and the 2007 Employee Stock Options Plan in the Bezeq Group. This assumption is theoretical as under the terms of the plans the offerees who exercise their options will not receive the number of shares underlying them, but as a cashless exercise they will receive the number of shares that reflect the financial benefit embodied in the options.

 
(2)
Including shares held directly by B Communications and its wholly-owned subsidiary.
 
In addition to our ownership of Bezeq shares as described above, a total of 4,000,000 ordinary shares of Bezeq are jointly held by Mr. Shaul Elovitch, our controlling shareholder, and his brother Mr. Yossef Elovitch. Further, 72,360 ordinary shares of Bezeq are held by Ms. Iris Elovitch, the wife of Mr. Elovitch, and 11,556 ordinary shares of Bezeq are held by Ms. Orna Elovitch, the daughter-in-law of Mr. Elovitch.  These shares total approximately 0.15% of the outstanding ordinary shares of Bezeq.
 
Permit to Control Bezeq Granted to Members of the Eurocom Group
 
As part of B Communications’ acquisition of the controlling interest in Bezeq, we, SP2, SP1 and other members of the Eurocom group applied for authorization to control Bezeq, pursuant to the Communications Law and Communications Order. On April 13, 2010, the control permit was granted subject to the condition that SP2 continues to be controlled exclusively by the other parties to the control permit, referred to as the Companies’ Control Permit. Concurrently, a separate control permit was also granted to Messrs. Shaul Elovitch and Yossef Elovitch, our controlling shareholders, referred to as the Individuals’ Control Permit.
 
According to the Companies’ Control Permit, the parties (through SP2) must hold not less than 30% of any type of means of control of Bezeq. Such percentage is permitted to decrease to 29% for a period of six months commencing from the date such holdings fall below 30%, in the event of dilution resulting from the exercise of stock options by Bezeq employees.  B Communications’ SP2 subsidiary which owns most of the Bezeq shares is deemed to hold the Bezeq shares directly notwithstanding that ownership is recorded in the name of a trust company wholly-owned by Bank Hapoalim, which was granted a lien over the Bezeq shares that were purchased from Ap.Sb.Ar. Holdings Ltd. as security for the repayment of the debt owed to Bank Hapoalim and other banking and financial institutions (approximately NIS 2.7 billion at December 31, 2012), referred to as the Lending Parties, for the funding of B Communications’ acquisition of the Bezeq interest.  In December 2012, SP2 transferred 29,662,168 ordinary shares of Bezeq (1.09%, of the outstanding Bezeq shares) to B Communications, which shares are not subject to the abovementioned lien and trust arrangement.
 
 
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In accordance with the Companies’ Control Permit, SP2, which holds the Bezeq shares is required to notify the Ministers of any changes in the composition of its board of directors every six months and if the change represents half or more of the members of the board of directors, within 30 days of the change. We and B Communications are also required to notify the Ministers of any “Exceptional Holdings” immediately upon becoming aware of such event.  We and B Communications are also required to notify the Ministers in the event a shareholder becomes a “Principal Shareholder” and regarding any 1% or more change in the holdings of a Principal Shareholder within 48 hours of becoming aware of such change. The terms “Exceptional Holdings” and “Principal Shareholder” are defined in the Communications Order and in our Articles of Association and are described below in Item 10B “Additional Information - Memorandum and Articles of Association - Rights Attached to Shares - Exceptional Holdings; Principal Shareholders.”
 
The parties to the Companies’ Control Permit may not transfer means of the control in Bezeq at a rate which requires the approval of the Ministers under the Communications Order, without their  prior written approval. The foregoing includes a transfer of the Bezeq interest in one transaction or a series of transactions, by one party or together with the other parties to the Companies’ Control Permit or the parties to the Individuals’ Control Permit. However, the parties may transfer the means of control of Bezeq among themselves, subject to compliance with certain conditions set forth in the Companies’ Control Permit
 
The Lending Parties undertook to comply with the provisions of the Communications Law, Communications Order and the lien permit granted to them relating to their rights under the credit agreement entered into among SP2 and the Lending Parties and the realization of the lien. The rights granted to the Lending Parties are deemed to be an encumbrance of collateral and the Lending Parties may not exercise rights pursuant to the means of control except as set forth in the lien permit. The lien permit was granted exclusively to the Lending Parties and any change in the composition of the Lending Parties or a modification of the credit agreement entered into among SP2 and the Lending Parties requires the prior written consent of the Ministers. The appointment of a receiver, on any grounds whatsoever, with respect to the holdings in SP2 or SP2’s holdings in Bezeq, will constitute grounds for canceling the Company’s Control Permit. The violation of the lien permit by the Lending Parties will constitute grounds for canceling such permit and for the appointment of a receiver and trustee, in accordance with the terms of such permit.
 
According to the Companies’ Control Permit, SP2 must at all times be held by an “Israeli Party,” as defined in the Communications Order, to the following extent:
 
 
·
At least 19% of each of the means of control of SP2 must be held by an Israeli Party at all times; or
 
 
·
At least 19% of the rights to vote at the general meeting of shareholders of SP2 and the rights to appoint directors of SP2 must be held by an Israeli Party at all times; and
 
 
·
The right to appoint at least one-fifth of the directors of Bezeq and Bezeq’s subsidiaries and not less than one director of each such company will be held by an Israeli Party at all times, provided that the percentage of the Israeli Party’s direct or indirect shareholdings in Bezeq is not less than 3% of any of the means of control of Bezeq. Indirect shareholdings will be calculated as the product of the Israeli Party’s lowest rate of holdings in each of the means of control in SP2, multiplied by the percentage of the holdings of the parties to the control permit in each of the means of control in Bezeq.
 
The Ministers have determined that we and B Communications are deemed to be “Israeli Parties,” so long as we and B Communications are controlled by a citizen and resident of Israel and that the ownership interest of Messrs. Shaul Elovitch and Yossef Elovitch in our company and our ownership in B Communications does not fall below 50% at all times.
 
The parties to the Companies’ Control Permit may not be controlled by any country, government company or a company controlled by a government company. The Companies’ Control Permit will terminate if the foregoing condition ceases to exist with respect to any such party without the approval of the Ministers. The Ministers may authorize a government company to hold an interest in any such party, provided that the government company’s aggregate direct or indirect holdings in Bezeq do not exceed 5% of any type of means of control of Bezeq and that it does not control such party.
 
In the event the Ministers find that the information they were provided is incorrect, that there has been a material change in the details provided by the parties to the Companies’ Control Permit which justifies its cancellation, or such parties failed to submit a required report, and the Ministers determine that there is probable cause to believe that the provision of the services that Bezeq is required to provide pursuant to its general license (including basic telephone, infrastructure, transmission and data transmission services and ancillary services) or the grounds for determining that any such service has been harmed, the Ministers may take action to cancel the Companies’ Control Permit. Upon its cancellation, all the shareholdings purchased under the Companies’ Control Permit will be deemed “Exceptional Holdings,” as described above.
 
 
- 18 -

 
 
The Companies’ Control Permit also authorizes an interested party in B Communications and our company that is not a party to the Companies’ Control Permit or the Individuals’ Control Permit to hold means of control in Bezeq, provided that such interested party does not hold more than 15% of any type of means of control of B Communications and our company. The foregoing authorization is subject to the condition (among others) that the percentage of holdings of the parties to the Companies’ Control Permit in B Communications, and of Eurocom Communications’ holdings in our company exceed 50% of the means of control in each of such companies at all times. We and B Communications are required to notify the Ministers of the shareholdings of any such interested party.
 
The provisions of the Companies’ Control Permit are subject to the terms of the Communications Order and Communications Law, as they may be amended from time to time.
 
B.           Business Overview
 
Since April 14, 2010, we, through our B Communications subsidiary have been the controlling shareholder of Bezeq (TASE:BZEQ), Israel’s largest telecommunications provider.
 
Bezeq is the principal provider of communications services in Israel, providing a broad range of telecommunications operations and services, including domestic fixed-line, cellular and international communication services, Internet services, multi-channel television, television and radio broadcasts,  satellite broadcasts, customer call centers, maintenance and development of communications infrastructures, provision of communications services to other communications providers and the supply and maintenance of equipment on customer premises, which is referred to as network end point, or NEP services. Bezeq was founded as a government company in 1980 and became a public company in 1990 with its shares traded on the TASE.

The Telecommunications Industry in Israel

The State of Israel is a highly developed, industrialized democracy. Real gross domestic product, or GDP, increased annually by 3.9% on average between 1996 and 2011, and GDP grew by 4.8% in 2011. Israel has seen marked improvements in most economic indicators in recent years. GDP growth has been steady and consistent over the past decade, with the exception of a contraction during the global slowdown early in the last decade and fluctuating growth rates surrounding the global financial crisis and the European debt crisis.
 
At December 31, 2012, the population of Israel was approximately eight million persons. The GDP of Israel was approximately $241 billion in 2012 and the GDP per capita was approximately $30,500. In 2012, Israel exported $91 billion of goods and services and the change in its consumer price index, or CPI, was 1.6%. Standard & Poor’s issued a long-term local currency sovereign credit rating of A+ (Stable) in 2012. This financial information was translated to US dollars based on the average representative rate of exchange for 2012 and the sources for that data are the Central Bureau of Statistics, Ministry of Finance of Israel and the Bank of Israel.

The Israeli telecommunications services industry had revenues of approximately NIS 30 billion (approximately $8 billion) in 2011.  Telecommunications services consist of several segments, which are highly competitive. Of the total telecommunications services revenues in 2011, approximately 56% was attributable to cellular services, approximately 26% was attributable to local landline voice and Internet access services, approximately 5% was attributable to international voice services and approximately 13% was attributable to multichannel television services. These figures changed substantially in 2012, reflecting a decrease in the overall revenues in the cellular market as a result of the increased competition and accelerated price erosion.  Cellular spending in 2012 was approximately 1.4% of GDP, in line with developed European economies and the United States. Israel has high penetration rates across all telecommunications services that are in line with developed economies such as in the European Union and the United States. These levels of penetration can be attributed to the rapid adoption rate of new technologies, high expenditures on telecommunications services by consumers and businesses and a relatively young population.
 
 
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Bezeq Group’s Strategy
 
The Bezeq Group’s objective is to be the market leader in all areas of the communications industry in Israel in both the business and private sectors. Bezeq’s strategy is to maintain its competitive position and continue being the customer’s first choice in telephony, internet and telecommunications. To attain this goal, Bezeq has imposed on itself a number of challenges:
 
 
·
Preservation of leadership status in an environment of intensifying competition (leader in service and strengthening of perceived values – innovative products, reliability, proximity to the customer);
 
 
·
Encourage the recruitment of new customers and enhance existing customer loyalty;
 
 
·
Creation of new sources of income by launching new services and products; and
 
 
·
Ongoing adaptation of the organization to the competitive environment and maintaining operational excellence.
 
To implement this strategy and attain these objectives, Bezeq uses and intends to continue to use the following means: leverage it leading position among business customers; offer diverse bundles of products and services that meet the business needs of customers; offer a total solution according to customer needs, while applying a strategy of commitment to service quality and availability; encourage  customer to migrate from basic services to managed solutions for organizational and inter-organizational connectivity; provide higher bandwidth to customers and sell advanced products and services on the new NGN; supply different billing solutions to suit customer needs; strengthen the position of Bezeq's telephony services, with emphasis on advanced applications and the penetration of advanced terminal handsets; and leverage the Bezeq Group’s assets for the purpose of providing customers a comprehensive communications solution. In order to attain its strategic objectives, Bezeq is working on improving its existing network and adapting it to its business goals, including by the deployment of optical fibers and investment in the core of the network.
 
Pelephone
 
Pelephone’s strategy is to grow its business to maintain its dominance in the provision of data services. To achieve its strategy, Pelephone intends to:
 
 
·
Increase revenues from data services by focusing on a target audience, increased marketing of mobile devices, cellular modems (NetStick) and smartphones;
 
 
·
Market supplemental value-added services to Internet surfing including anti-virus solutions, backup and data storage, and music and video services;
 
 
·
Increase data transfer speeds and maintain the our reputation as the leading carrier with the fastest network in Israel;
 
 
·
Continue the recruitment and retention of customers;
 
 
·
Increase customer satisfaction;
 
 
·
Constantly improve its network infrastructures; and
 
 
·
Continue to streamline its operations.
 
Bezeq International
 
Bezeq International’s strategy is to continue to maintain its leadership position in the internet services market in Israel for private and business customers, while maintaining its revenue in its traditional markets. To achieve its strategy, Bezeq International intends to:
 
 
·
continue its leadership in the Internet access market while continuing to realize the potential inherent in the migration to the new generation of infrastructure networks;
 
 
·
Expand its range of cloud-based solutions;
 
 
·
Strengthen its status as one of the leading Information Communications Technology, or ICT, players in Israel; and
 
 
·
Increase customer satisfaction by intensifying and expanding service offerings (automated services, social networks, etc.).
 
 
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DBS
 
DBS’s objective is to maintain its business and competitive status in the broadcast market while increasing its operating margins.  To achieve these goals, along with its efforts to reduce costs and streamline operations, DBS intends to:
 
 
·
Invest considerable effort in marketing and sales;
 
 
·
Develop a marketing strategy designed to attract new subscribers;
 
 
·
Retain existing customers;
 
 
·
Continue to improve the array of services offered to subscribers;
 
·      Create differentiation and innovation in its broadcast content and expand the range of content relative to HOT’s content;
 
 
·
Increase the amount of content purchased by each subscriber and expand DBS's value-added services; and
 
 
·
Invest in the development and integration of advanced technologies and new services.

These efforts include DBS's efforts to increase the rate of penetration of advanced services, including the use of personal video recorder, or PVR, decoders and VOD and HD services among its subscribers and to provide its content on additional platforms to increase DBS revenues and enhance subscriber loyalty to DBS's services.
 
Bezeq’s Ownership Interests

The following chart illustrates Bezeq’s ownership interests in its principal subsidiaries and affiliates, as at April 22, 2013:
 
 
The Group has four principal areas of operation, which are reported as business segments in Bezeq’s consolidated financial statements:
 
 
Bezeq domestic fixed-line communications - Primarily includes Bezeq’s operation as a domestic operator, including fixed-line telephony services, Internet services, transmission services and data communications.
 
 
Pelephone Communications Ltd. - Provides cellular mobile services (cellular communications), marketing of end-user equipment, installation, operation and maintenance of cellular communications equipment and systems.
 
 
Bezeq International Ltd. - Bezeq International is an Internet service provider, or ISP, and also provides international communications services and NEP services.
 
 
D.B.S. Satellite Services (1998) Ltd. - Provides multi-channel broadcast and value added services via satellite.
 
As a result of the August 2009 decision of the Israeli Supreme Court to not approve the merger of Bezeq and DBS, Bezeq ceased consolidating the results of DBS into its financial statements and accounts for its investment in DBS under the equity method.  Bezeq reports the operations of DBS as a segment in its consolidated financial statements. Bezeq holds 49.78% of the shares of DBS as well as options to purchase additional shares, with the balance held by Eurocom D.B.S. Ltd., or Eurocom DBS, which is indirectly controlled by Mr. Shaul Elovitch. Accordingly, cooperative ventures between it and the Bezeq Group companies (such as agreements for mutual marketing of products and services) must currently be approved as transactions in which the controlling shareholder in Bezeq has a personal interest, which process could impede the business flexibility of the Bezeq Group in such cooperative ventures. In view of the position taken by the Israeli Antitrust Commissioner and the ruling of the Supreme Court in 2009, Bezeq is not permitted to increase its holdings in DBS or control it, which limits the Bezeq Group's ability to benefit fully from the advantages that could have been achieved from the inclusion of DBS in the Bezeq Group. DBS believes that if these regulatory limitations and structural separation and the other limitations applicable to cooperative ventures between it and the other companies in the Group remain in effect, they will have a detrimental effect on DBS's financial results.
 
 
- 21 -

 
 
Bezeq also includes a category of “Other” in its consolidated financial statements, which includes customer call center services through its Bezeq Online Ltd. subsidiary, investments in a venture capital fund and its ownership of Walla! Communications Ltd., or Walla!, a popular Israeli provider of Internet and portal services.  In April 2012, a tender offer published by Bezeq for the purchase of all the shares held by the public in Walla! was successfully completed. Accordingly, all of the Walla shares held by the public were acquired and Walla! was delisted from the TASE and became a wholly owned subsidiary of Bezeq.
 
The Bezeq Group holds over 200 trademarks including its principal trademarks: Bezeq, B (Bezeq's logo) and Pelephone.
 
For detailed information about Bezeq’s business, see Bezeq’s Periodic Report for 2012, prepared in accordance with Israeli Securities Regulation (Periodic and Immediate Reports), 5730-1970, which we filed on a Form 6-K with the SEC on March 25, 2013.
 
Regulatory Environment
 
The Israeli communications industry is regulated and controlled by the Israeli Ministry of Communications and to a lesser degree by other governmental authorities.  The Bezeq Group is subject to government supervision and regulation relating to, among other things, its operations, licensing, determining permitted areas of activity, determining tariffs, competition, environmental matters, payment of royalties, obligation to provide universal service, ability to hold its shares, relationships between Bezeq and its subsidiaries and, in certain events, prohibitions as to the termination or restriction of its services (which may force Bezeq to provide services at a loss).  This supervision and regulation has resulted in governmental intervention in the past.  Bezeq’s business and operations could be adversely affected by decisions of its regulators, in particular the Ministry of Communications as well as changes in laws, regulations or government policy affecting its business activities.
 
Competition Policy of the Ministry of Communications
 
On May 2, 2012 the policy document concerning expansion of competition in the fixed-line communications wholesale market was published, pursuant to which the Minister of Communications adopted the main recommendations of the Hayek Committee.  The key points in this policy document are as follows:
 
 
·
Owners of universal fixed-line access infrastructures, who provide retail services, including Bezeq, will be obligated to sell wholesale services to holders of telecommunications licenses, including Bitstream access, lease of access segments, dark fibers, tubes and transmission services, on a non-discriminatory basis and with no discounts for size. In this regard, a procedure was established for negotiating an agreement for these services and as soon as such agreement is signed, the infrastructure owner will publish a “shelf offering” for the sale of the services based on the agreement and which also includes additional services as the Ministry of Communications determines from time to time. In certain circumstances, the Minister of Communications has the power to stipulate conditions or prices for the services. The infrastructure owners must submit to the relevant license owners the distribution of their existing infrastructures, with exceptions to be defined.
 
 
·
Upon publication of such “shelf offering,” other entities may also purchase wholesale services on the same terms from the infrastructure owner.  Under this procedure, Bezeq will be able to provide wholesale telephony services to its subsidiaries that are not supplied over a broadband network, provided that these services are also available to everyone and without discrimination.
 
 
·
Within nine months of publication of the “shelf offering,” the Minister of Communications will eliminate the structural separation between the infrastructure provider who published the aforementioned offering and the international call providers and ISPs, changing it to an accounting separation, unless the Minister believes that this will adversely affect competition or the public interest. As a result, Bezeq will be able to offer subsidized plans. If the wholesale market develops and the degree of competition allows, the Minister of Communications will consider an easing or cancellation of the structural separation between an infrastructure provider and a cellular operator who has an interest in such provider.
 
 
- 22 -

 
 
 
·
The Minister of Communications will review the subject of the unbundling of broadcast services included in the joint bundles, which also include Bezeq services (fixed or mobile) or broadband access services. The structural separation between the infrastructure providers and multi-channel television sector will be eliminated by granting suppliers without nation-wide fixed-line infrastructure a reasonable possibility to provide a basic television service package over the Internet.
 
 
·
If a wholesale market does not develop in an approved manner (based on indices to be defined for this purpose) within 24 months of the publication of the policy document, the Minister of Communications will take action to implement structural separation between the infrastructure and the services provided by general domestic carrier license holders.
 
 
·
Within six months of publication of the “Shelf Offering”, the Minister of Communications is required to take action to change the method of oversight of Bezeq's prices so that prices will be controlled by fixing a maximum price.
 
 
·
Within nine months of publication of the “Shelf Offering”, the Ministry of Communications is required to formulate regulations aimed at increasing the investment in and upgrade of fixed-line communications infrastructures in Israel.
 
Bezeq is preparing to implement a wholesale market and to provide wholesale services. The effects on Bezeq will depend, to a large extent, on the conditions, arrangements, and similar variables, which have not yet been defined.  Bezeq believes that in addition to the possible negative impact on revenues and the rendering of end-to-end services to subscribers, the implementation of the wholesale market may have positive effects, including the possible elimination of Bezeq’s structural separation and the regulatory control over Bezeq's prices.
 
On June 12, 2012, the Ministry of Communications convened an engineering forum of the operators to discuss the wholesale services, including the service portfolios for the provision of certain service configurations of Bitstream Access and passive infrastructures, concurrent with advanced negotiations that Bezeq is holding directly with various operators.  In November 2012, Bezeq entered into an agreement with Partner to provide Bitstream Access. The agreement defines the principles and configuration of the service for the provision of Internet access that will support media, voice and TV Internet services.  Should the parties fail to reach agreement on prices, they will wait for the peremptory decision of the Ministry of Communications.  Bezeq and Partner agreed to work towards signing a detailed agreement based on the principles prescribed in the agreement and that after signing such detailed agreement, Bezeq will be able to publish the agreement as a shelf offering (as described above), whereby any other entity may apply and receive the service under the same conditions.  Similarly, in March 2013, Bezeq entered an agreement with Xfone for the provision of Bitstream Access for a “small supplier,” which agreement will also serve as a shelf offering.
 
On December 9, 2012, the Ministry of Communications' hearing of Bezeq's instruction was received, whereby Bezeq will provide to Cellcom or to any license holder who applies to it for the purpose of exercising a wholesale market, detailed information about the sites, facilities and distribution of its network. Bezeq submitted a detailed opinion to the Ministry concerning its objections to the aforementioned instruction and process, which Bezeq believes contains administrative deficiencies, lack of jurisdiction and are unreasonable.
 
Royalties
 
The Communications Law states that a holder of a license for the provision of telecommunications services shall pay royalties to the State of Israel out of its revenues from providing the services named in the applicable Israeli royalties regulations. Such regulations impose on a general domestic carrier licensee (which includes Bezeq), an international call service license (which includes Bezeq International) and a cellular licensee (which includes Pelephone), a duty to pay royalties on its revenues (excluding VAT) from the services listed under such regulations.
 
In 2012, the applicable rate of royalties was reduced on average to 1.75% for Bezeq and DBS, to 1.3% for Pelephone, (the rate of royalties for Bezeq International is 1%), and from 2013 it will be 0% for all of the Bezeq Group companies.
 
Bezeq's paid approximately NIS 52 million in royalties in 2012  compared to NIS 56 million in royalties in 2011. The royalty rate for 2012 and 2011 was 1.75% of taxable income (as defined in the regulations).
 
 
- 23 -

 
 
Limitation on the exit penalty a license-holder may collect from a subscriber
 
Under an amendment to the Communications Law, exit fees cannot be collected from a subscriber whose average monthly bill is less than NIS 5,000 who entered into an agreement after August 8, 2011, nor can the subscriber be denied a benefit that he or she would have received had he or she not terminated the agreement. Commencing November 8, 2011, the amendment also applies to subscribers who entered into agreements before the amendment became effective and subsequently cancelled their agreements. Such subscribers are subject to a cancelation fee of up to 8% of their average monthly bill, multiplied by the number of months remaining to the end of the term of the commitment. In addition, a license-holder may not demand immediate payment of the balance for the terminal equipment in the event of cancellation of the agreement. This amendment resulted in an increase in the churn rate and in certain adjustments to the terms in the subscriber agreements in order to conform them to the amendment.
 
Cellular license-holders are regulated by provisions limiting the exit fee that may be collected from certain subscribers who terminate their agreement before the end of the commitment period to 8% of the subscriber's average monthly bill at the cancellation date. On April 1, 2012, an amendment to the Communications Law was published, eliminating disconnection fees for customers that hold up to 100 phone lines and who entered into agreements with the cellular operator subsequent to November 1, 2011.  Also effective in 2013, a subscriber's commitment to receive cellular services may not be dependent on such subscriber's agreement with a license holder to purchase, rent, borrow or lease terminal equipment.
 
Consumer protection
 
Changes in consumer legislation regularly affect the operations of Bezeq and its subsidiaries. Bezeq and its subsidiaries are subject, among other things, to the Consumer Protection Law, 5741-1981, or the Consumer Protection Law and regulations. The Consumer Protection Law allows consumers to cancel transactions and to disconnect from on-going services and requires customers to give their express consent to continue the service after the end of the term of the contract. Provisions concerning a refund of charges collected from subscribers, which are not in accordance with an agreement plus fixed handing charge are prescribed by law, as well as a maximum waiting time for a human response. In addition, a number of pending legislative proposals provide for additional consumer protection and may affect the conduct of Bezeq and its subsidiaries with their subscribers.
 
Limitations on creating charges on the assets of the Bezeq Group
 
The Communications Law, the Communications Order and some of the communications licenses of the Bezeq Group, contain limitations on the grant of rights to a third party in assets used to provide the essential service or in the assets of the license, including the need to obtain regulatory approval to create charges on these assets. In some instances, such as Pelephone's cellular operator's license and Bezeq International's general (ITS) license, there are exceptions permitting the creation of charges in favor of banks without the need to obtain the regulator's approval in advance, provided that the charge agreement includes provisions to ensure that the enabled services will not be affected if the bank exercises the charge. In addition, under the provisions of the law and the communications licenses, the license and the resulting rights are not transferrable and they cannot be pledged or confiscated (with certain exceptions).
 
Bezeq and Pelephone have provided undertakings to certain financing entities that they will not pledge their assets without simultaneously creating a charge of the same class, rank and amount (negative charge) in favor of those financing entities. DBS created current charges on all its assets and fixed charges on certain of its assets, which include, among other things, restrictions on the creation of additional charges without obtaining the agreement of the financing entities.
 
Gigabit Ethernet connection  for ISPs
 
On June 26, 2012, the Ministry of Communications published the findings of a hearing seeking operators' comments on changes to the existing regulations for connecting ISPs to Bezeq's network and to the Hot Telecom network, which determined that: (i) the "high-speed access by means of Internet providers" (Bezeq's XDSL) portfolio and Hot Telecom's "broadband access for ISPs" portfolio, will be amended so that these services will include all the necessary components for providing those buying the service with surfing speed, including conveying traffic on the core and access networks; (ii) the payments imposed on the ISPs for gigabits will be eliminated; and (iii) infrastructure owners will increase the price for the Internet access services for the end customer to include the gigabit segments. According to the hearing, the infrastructure owners will be obligated to provide gigabit connections at a speed to be derived from the "load ratio" (a percentage of the aggregate speeds ordered by all the supplier's subscribers) as the Ministry determines from time to time. At present, the Ministry is of the opinion that the appropriate load ratio is 5%. Bezeq objected to this change and believes it is not generally accepted in the telecommunications industry, and expressed its opinion that the hearing and the proposed arrangement contain administrative flaws and are unreasonable. Bezeq published new tariffs for these services.
 
 
- 24 -

 
 
The regulations affecting the operating segments of the Bezeq Group are described in the sections of this annual report relating to each of such segments.
 
Competition in the Israeli Communications Market
 
The communications industry around the world and in Israel has developed rapidly. The technology and corporate structure and regulations governing the communications industry in Israel has undergone and continues to undergo significant changes. A number of communications groups operate in the Israeli communications market on the basis of cooperative marketing among a number of companies and/or among companies with common ownership for the supply of comprehensive communications service packages, thus utilizing the marketing and operational advantages inherent in such a structure.
 
In 2011, a tender for the grant of frequencies and a license to cellular operators that own infrastructure was issued. The tender was won by Hot Mobile, which is one of the four existing operators, and Golan Telecom.  In May 2012, Golan Telecom and Hot Mobile launched their operations, which immediately caused intensified competition in the cellular market among all the cellular operators.
 
The Ministry of Communications has also prompted increased competition by:
 
 
separating infrastructure and service providers;
 
 
granting new licenses and encouraging new and innovative technologies; and
 
 
mandating number portability. Number portability exists in the fixed-line and cellular telephony market, enabling customers to immediately switch between various communication operators without changing their telephone number. Bezeq believes that number portability has significantly increased the churn rate in its fixed-line telephony services.
 
In 2012, competition in the telecommunications industry, particularly in cellular telephony, intensified with the entry of the new operators, Golan Telecom and Hot Mobile, and the introduction of comprehensive service packages, including communications packages for a fixed price with unlimited use. This intensified competition resulted in lower prices, a decrease in the sale of cellular terminal equipment, a decrease in the use of fixed-line telephony minutes and higher churn rates, which has affected the Bezeq Group's revenues and operational results. To reduce the impact on performance, the Bezeq Group's companies are introducing streamlining and other measures to improve the services they provide and differentiate them from their competitors.
 
While in the past competition in the communications market was mainly among the independent communications service providers in each segment, more recently the communications market has consolidated and competition evolved to be among large communication groups operating in most, if not all, of the segments of this market.
 
The Israeli communications market is dominated by four main groups, the Bezeq Group, the IDB group (which controls Cellcom and 013 NetVision), the Partner group, which purchased 012 Smile Communications Ltd., or 012 Smile, and the HOT group, each having interests in some, or all, of the main communications sub-sectors.
 
IDB Group - The IDB Group provides communications services through Cellcom, a publicly held company, and its wholly owned subsidiary, Netvision Ltd., or Netvision. These companies provide  cellular telephony services (including cellular Internet), fixed-line telephony mainly to business customers through its own infrastructure, transmission and data communication services for business customers through Cellcom's own transmission network, ISP services, international call services and fixed-line telephony services using VoB technology.
 
Partner Group - The Partner Group provides communications services through Partner, a public company, and 012 Smile, which provide cellular telephony services (including cellular Internet), fixed-line telephony, transmission and data communications, ISP services, international call services and fixed-line telephony using VoB technology
 
HOT Group - The HOT Group provides communications services through HOT and through Hot Mobile which are commonly owned. The Hot Group owns a cable infrastructure that is deployed nationwide, and it provides multi-channel television services though HOT, as well as fixed-line telephony services. The HOT Group also has a nationwide Internet infrastructure and provides transmission and data communications services through HOT Telecom, a subsidiary of HOT. Hot Mobile (previously known as Mirs Communications Ltd., which was acquired by HOT in 2011) provides cellular communication services using iDEN technology. The HOT Group is subject to limitations separating the structure of Mirs Communications Ltd. from that of HOT Telecom and HOT Broadcasting, including full segregation of management, as well as the separation of assets and employees. Hot Mobile is prohibited from transferring commercial information to HOT Telecom and HOT Broadcasting, or from receiving such information. However, Hot Mobile is permitted to offer and market HOT Telecom or HOT Broadcasting services that are not part of the joint bundles and to transfer relevant information for this purpose.
 
 
- 25 -

 
 
In December 2009, HOT-Net, a subsidiary of HOT, was granted an ISP license, subject to similar structural separation limitations between HOT-Net, HOT and HOT Telecom and limitations on marketing joint service packages that include HOT-Net's Internet access. Among the limitations are an obligation to market service packages that correspond to competing ISPs, and an obligation to sell ISP services separately and on the same terms as they are sold when part of the service package (unbundling). In February 2012, HOT-Net launched operations.
 
Other Developments in Competition
 
In addition to HOT's cable and optical fiber network and the optical fiber infrastructures of Cellcom and Partner, there are a number of utility and transportation infrastructures in Israel that have the potential to serve as communications infrastructures, based on optical fibers networks, which are mostly owned by government companies and entities. Among these are the Israel Electric Company, Israel Railways, Mekorot (water grid), pipeline infrastructures companies and the Cross Israel Highway Company. Some municipalities are also trying to create an alternative to cable network services of communications license-holders by deploying their own infrastructures.
 
The government of Israel is conducting a public process to choose an investor for a communications venture that will control the establishment of a third communications infrastructure company in Israel, which will use and operate a fixed-line communications infrastructure based on the electricity grid. Under this proposal the Israel Electric Company will own 40% of the share capital in the venture. According to various publications, on December 26, 2012, a group of investors headed by "Viva Europa" submitted an offer to the selection committee. The selection committee will review the economic, technology, and legal aspects of the offer submitted by that group to determine if the offer meets the conditions of the selection process. In Bezeq's estimation, the establishment of such a communications company, which would compete with Bezeq in providing infrastructure, and particularly if that new company is permitted to provide services to operators and business customers while easing the obligation for universal deployment of a fiber to the home network, could adversely affect its  operations and results.
 
BEZEQ FIXED-LINE BUSINESS
 
General
 
Bezeq has a general license to provide domestic fixed-line communication services in Israel. As a domestic carrier, Bezeq provides fixed-line telephony services, Internet infrastructure and access services, transmission and data communication services.
 
The following table provides summary condensed information concerning Bezeq’s fixed-line communications segment for the three years ended December 31, 2012.
 
 
 
2010
 
 
2011
 
 
2012
 
                         
Revenues (NIS millions)
 
 
5,263
 
 
 
4,648
 
 
 
4,630
 
Operating profit (NIS millions)
 
 
2,043
 
 
 
1,695
 
 
 
1,923
 
Depreciation and amortization (NIS millions)
 
 
690
 
 
 
688
 
 
 
730
 
Operating profit before depreciation and amortization (NIS millions)
 
 
2,733
 
 
 
2,383
 
 
 
2,653
 
Net profit (NIS millions)
 
 
1,426
 
 
 
1,102
 
 
 
1,194
 
Cash flow from operating activities (NIS millions)
 
 
2,140
 
 
 
2,106
 
 
 
2,009
 
Payments for investments in property, plant and equipment and intangible assets (NIS millions)
 
 
1,032
 
 
 
1,165
 
 
 
958
 
Proceeds from the sale of property, plant and equipment and intangible assets (NIS millions)
 
 
132
 
 
 
228
 
 
 
300
 
Free cash flow (in NIS millions) (1)
 
 
1,240
 
 
 
1,169
 
 
 
1,351
 
Number of active subscriber lines at the end of the period (2) (in thousands)
 
 
2,366
 
 
 
2,367
 
 
 
2,268
 
Average monthly revenue per line (NIS) (3)
 
 
81
 
 
 
76
 
 
 
73
 
Number of outgoing minutes (in millions)
 
 
10,699
 
 
 
9,758
 
 
 
8,691
 
Number of incoming minutes (in millions)
 
 
6,547
 
 
 
6,240
 
 
 
6,225
 
Number of Internet subscribers at the end of the period(2) (in thousands)
 
 
1,066
 
 
 
1,111
 
 
 
1,169
 
Percentage of subscribers using NGN services out of total Internet subscribers
 
 
34
%
 
 
51
%
 
 
62
%
Average monthly revenue per Internet subscriber (NIS)
 
 
75
 
 
 
80
 
 
 
81
 
Average bandwidth per Internet subscriber (Mbps)
 
 
4.3
 
 
 
6.7
 
 
 
9.6
 
Churn rate (4)
 
 
12.6
%
 
 
11.6
%
 
 
15.3
%
 
 (1)
Cash from operating activities less purchase of property, plant and equipment and intangible assets, net.
 
 
- 26 -

 
 
(2)
Inactive subscribers are subscribers whose Bezeq lines have been physically disconnected (except for a subscriber during (roughly) the first three months of the collection process).
 
(3)
Excluding revenues from transmission and data communication, Internet services, services to communications operators and contract and other works, calculated according to average lines for the period.
 
(4)
Number of telephony subscribers who left Bezeq fixed-line services during the period, divided by the average number of registered subscribers in the period.
 
Number of active subscriber lines, average monthly revenue per line, and number of outgoing usage minutes were corrected retrospectively and are presented after eliminating the effect of public call boxes operated with cards. Additionally, the number of active subscriber lines and average monthly revenue per line, or ARPL, were corrected retrospectively and include IP Centrex lines.
 
Government Regulations
 
Bezeq is subject to control and restrictions under the Antitrust Law and was declared a monopoly in its main fields of activity, including basic telephone services, provision of communications infrastructure services, transfer and transmission of broadcasting services to the public, provision of high-speed access services through the access network to subscribers and provision of high-speed access services for ISPs through a central public telecommunications network.
 
Bezeq was also declared a provider of essential telecommunications services under the Communications Order. By virtue of that declaration, Bezeq is required to provide certain types of services and may not interrupt its provision of such services or narrow them. Among these services are basic telephone services, infrastructure services, transmission services and data communication services including, interconnect, and other services listed in the schedule to the Communications Order.
 
The main provisions of the Communications Order are:
 
 
Limitations on the transfer and acquisition of means of control, which includes a ban on holding 5% or more of means of control of a certain kind without the prior written approval of the Ministers.
 
 
Transfer or acquisition of control in Bezeq requires the approval of the Ministers by means of a Control Permit. The Control Permit establishes the minimum holding percentage in each of the means of control in Bezeq by the holder of the Control Permit where a transfer of shares or an issuance of shares by Bezeq, as a result of which the percentage of ownership of the Control Permit holder falls below the minimum percentage, is prohibited without the prior approval of the Ministers, subject to permitted exceptions (including, an issuance to the public under a prospectus, or sale or private placement to institutional investors).
 
 
Holdings not approved in compliance with the Communications Order will be considered “exceptional holdings” and any exercise of a right by virtue of exceptional holdings will not be valid. The Communications Order also contains provisions authorizing the Ministers and Bezeq to apply to the courts with an enforced sale of exceptional holdings.
 
 
A duty to report to the Ministers upon demand is imposed on Bezeq with respect to any information on matters relating to provision of an essential service.
 
 
75% of the members of the Board of Directors of Bezeq must be Israeli citizens and residents who have security clearance from the General Security Service.
 
 
The Chairman of the Board of Directors of Bezeq, the external directors (within the meaning of the Israeli Companies Law), the chief executive officer, the deputy chief executive officer and other office-holders in Bezeq as listed in the Communications Order, must be Israeli citizens and residents and have a security clearance appropriate to their functions.
 
 
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Nationality requirements are established for the controlling shareholder in Bezeq: an individual must be an Israeli Entity (as defined in the Communications Order); a corporation must be incorporated of Israel, the center of its business must be in Israel, and an Israeli Entity must hold at least 19% of the means of control of such company.
 
 
The approval of the Ministers is required for the grant of rights in certain assets of Bezeq (switches, cable network, transmission network and data bases and banks). In addition, the grant of rights in means of control in the subsidiaries of Bezeq, including allotment of more than 25% of the shares in a subsidiary, requires the approval of the Ministers.
 
 
Provisions were established for the protection of computerized systems and the purchase of hardware and software.
 
 
Certain actions of Bezeq require the approval of the Minister of Communications, including voluntary liquidation, a settlement or arrangement between Bezeq and its creditors, a change or reorganization of the structure of Bezeq and a merger or split of Bezeq.
 
 
The Minister of Communications granted Bezeq immunity from liability from certain types of damages listed in the Communications Law. In addition, the Communications Law contains exceptions to criminal and civil liability for an act done in fulfillment of a directive to provide services to the security forces.
 
Competition Laws
 
Bezeq’s general license for fixed-line communication services obligates it to ensure that its relationships with its principal subsidiaries do not result in favoring them over their competitors. Bezeq is also subject to various limitations as a result of its declaration as a monopoly in the fixed line services business, as well as limitations set forth in merger approvals granted by the Israeli Antitrust Commission. Separation is required between the managements of Bezeq and its principal subsidiaries, as well as separation between the financial and marketing systems, assets and employees, which result in high administrative overheads. Bezeq is also subject to limitations with respect to the offering of joint service packages with those companies, which adversely impacts its business, particularly in light of the entry into the market of communications companies competing directly with Bezeq in most of its areas of operation based on the provision of bundled services to the customer.
 
On October 11, 2011, Bezeq was notified by the Israeli Antitrust Commissioner of the possible finding that Bezeq violated the provisions of the Antitrust Law by, among other things, not providing infrastructure and transmission services for telephony and Internet services (domestic operator) to its competitors, Cellcom, and Partner. In October 2010, Bezeq started to provide infrastructure and transmission services to competing telecommunications operators.
 
On October 16, 2012, the Ministry of Communications published a hearing according to which it is considering granting permission to the domestic carrier license holders to offer the use of WLAN (Wireless Local Access Network) technology by installing access points throughout Israel and the removal of the connection restriction on "delineated premises."  The Ministry of Communications has not published a final decision as yet.
 
On February 11, 2013, the Antitrust Authority informed Bezeq that the Commissioner was considering issuing a ruling to the effect that Bezeq had abused its position as a monopoly in that it had adopted a prohibited practice in connection with a campaign in which it had offered new subscribers a certain promotional rate. The Commissioner contends that the price set by Bezeq places competitors who wish to offer this service at a disadvantage, as the price of the critical input for supply of the service is higher than the price of the final service which Bezeq offered its customers. Bezeq believes that it acted lawfully and in accordance with the Ministry of Communication’s approval, and it intends to exercise its right to seek a hearing.
 
Bezeq has adopted an internal compliance procedure containing guidelines and an internal reporting and control system, the purpose of which is to ensure that the activities of Bezeq and its employees are carried out in accordance with the provisions of the Antitrust Law.
 
Control of Bezeq’s Tariffs
 
Bezeq’s telephony tariffs are prescribed in regulations promulgated by the Minister of Communications with the consent of the Minister of Finance. As a result of a deliberate regulatory policy, the monthly usage tariff for a telephone line is set at a level that does not cover the costs involved in providing it (a situation known as “accessibility deficit”). This deficit has been reduced over the years, but still exists.  The tariffs for Bezeq’s controlled services (telephony and others) which are fixed in regulations promulgated under the Communications Law were updated so that on average, Bezeq's controlled tariffs will erode in real terms.
 
 
- 28 -

 
 
As a result of a ruling by the Minister of Communications, who adopted the majority of a report from a commission on the rules of competition in the communications industry, or the Gronau Report, so long as the Bezeq Group's market share remains higher than 60%, control of Bezeq's prices will continue in the format of mandatory price fixing. On May 31, 2012, new regulations were published, which provide that an update of tariffs to be made in June 2013 will include an aggregate update for the prior two years.
 
Under the Communications Law, if tariffs are fixed for controlled services, the Minister of Communications may, with the consent of the Minister of Finance, approve a request made for an alternative payment package for a service package. Bezeq may offer an alternative payment package after the period defined in the law unless either Minister of Communications or Minister of Finance announces their objection. The Gronau Report states  that an alternative payment package will be approved only of it is worthwhile for 30% or more of the subscribers who consume the services offered in the package and the smaller the market share of the Bezeq Group in fixed-line telephony, the higher the maximum discount rate permitted in an alternative payment package may be.
 
Bezeq's controlled tariffs are reviewed by a public committee every few years, at which time Bezeq is exposed to material changes in its tariff structure and tariff levels. The review mechanism for the controlled tariffs has resulted in the erosion of the tariffs over time. Control of the tariffs creates or could create difficulties for Bezeq in providing an appropriate and competitive response to changes in the market and in offers of competitive prices on short notice. In addition, the restrictions on granting discounts on tariffs limit Bezeq’s ability to participate in certain tenders.
 
Under the Communications Law, a license holder can demand reasonable payment for a telecommunications service for which payment is not fixed. Bezeq sets the tariffs for these types of services.
 
Service Packages
 
Historically, the structural separation limitations prevented Bezeq from marketing joint service bundles. Following the decrease of Bezeq's market share to below 85%, in May 2010 Bezeq was permitted to offer private subscribers joint service bundles with the subsidiaries, and in July 2012 Bezeq was permitted to offer a joint bundle to business subscribers, subject to approvals by the Ministry of Communications and other conditions contained in the Domestic Carrier license, including the following:
 
 
The service packages must be able to be unbundled so that a service included in a package will be offered separately and on the same terms; and
 
 
At the time a request for approval of a service packages is submitted, there must be a group of services in similar format being marketed to a private subscriber as a package by a license-holder who is not a subsidiary of Bezeq, or there is a group that includes license-holders who provide a private subscriber with all the services included in the joint service packages.
 
Joint service packages marketed by Bezeq’s subsidiaries that include the services of Bezeq are also subject to similar limitations, including unbundling (except for a service package marketed by a subsidiary that only contains Bezeq's Internet infrastructure service).  The Ministry does not view these amendments to the licenses as changes in the previously existing practice with respect to the ability of ISPs to offer business customers the ISP component, without this being considered a "joint services” package.
 
These limitations, and in particular the unbundling obligation, which severely limit the Bezeq Group's ability to offer discounts on the components of a service package, place the Bezeq Group in a competitively inferior position compared to the competing communications groups, that are not subject to similar limitations in marketing joint service packages (other than a limitation on marketing a joint service packages by HOT-Net and other companies in the HOT Group).
 
On July 3, 2012, Bezeq's license was amended to permit the offer of joint service bundles with its subsidiaries to business subscribers, subject to the approval by the Ministry of Communications and subject to the other limitations set forth in Bezeq’s license.
 
Deployment of Communications Facilities
 
The deployment and manner of set-up of communication facilities in Israel are regulated by the National Outline Plan for Communications 36, or NOP 36, and NOP 56 (in the Palestinian Administered Territories). These plans were designed to ensure coverage for transmitting and receiving radio, television and wireless communications, while avoiding radiation hazards, minimizing damage to the environment and simplifying and increasing the efficiency of the processes involved in setting up new facilities.
 
 
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NOP 36. Part A of NOP 36 deals with guidelines for erecting small and miniature broadcasting installations.  Bezeq has obtained building permits for most of its small broadcasting installations in accordance with NOP 36A. From time to time, a need arises to add broadcasting installations which require that building permits be obtained in accordance with NOP 36A. Given the exemption granted under the orders of the Planning and Construction Law and of the Communications Law, Bezeq believes that it is not obliged to obtain building permits for miniature broadcasting installations, which are “wireless access facilities” under those laws.  There are a number of initiatives to cancel this exemption, and its cancellation could have materially adverse implications, including making it difficult for Bezeq to provide universal service as required by the provisions of its license.
 
NOP 56. NOP 56 became effective in June 2008 and regulates the manner of erection and licensing of communications facilities in the Palestinian Administered Territories. NOP 56 has transition provisions for facilities erected with a permit for small installations.  The guidelines also include a requirement for obtaining a communications license and the receipt of necessary consents from the Commissioner of Government Property at the Civil Administration. Bezeq has obtained licenses for 72 installations in the Palestinian Administered Territories and is in the process of obtaining licenses for an additional nine installations in the Palestinian Administered Territories.
 
Bezeq's Carrier License
 
The principal provisions of Bezeq’s Carrier License include:
 
 
Scope of license - Bezeq must provide its services to all on equal terms for each type of service, irrespective of the location or unique cost. The license is unlimited in time; the Minister may modify or cancel the license or make it contingent; the license and any part of it cannot be transferred, no charge can be imposed on it, nor can it be subject to attachment.
 
 
Principles of structural separation - Bezeq must operate under the principles of structural separation. In order to comply with this requirement, Bezeq employs various compliance procedures and provides its employees with training sessions and periodic refresher courses on the relevant procedures. On July 3, 2012, Bezeq's license was amended to permit the offer to business subscribers of joint service bundles with its subsidiaries, subject to the approval by the Ministry of Communications and subject to the other limitations set forth in Bezeq’s license.
 
 
Marketing joint service bundles - Bezeq may request permission to market joint service bundles, subject to certain limitations.
 
 
Tariffs – If Bezeq provides a service or package of services for which no tariff is set under the Communications Law, it must be offered at a reasonable price to all, without discrimination and at a uniform tariff.
 
 
Operations of networks and service standards - Bezeq is required to maintain and operate its network and provide its services at all times, including at times of emergency, in an orderly and proper manner commensurate with the technical requirements and the nature of the service, and to work towards improving its services. The license includes an appendix, “Service Standards for the Subscriber”, which is to be amended after Bezeq provides the Ministry with data. Bezeq submitted its proposal for an amendment to the appendix, adapting it to the current state of affairs and the licenses of other operators, but the amendment has not yet been adopted.
 
 
Interconnect and use - Bezeq is required to provide interconnect services to other public switching networks and to provide the option of use of such services by other license holders Bezeq has a duty to provide infrastructure services to other license holders on reasonable and equal terms and must refrain from providing preferable terms to its affiliates.
 
 
Security arrangements - Provisions have been made for the operation of Bezeq's network in times of emergency. Bezeq is required to design and operate its network in a manner that will prevent its collapse in an emergency. Bezeq provides special services to the defense forces and is required to provide telecommunications services and maintain terminal equipment infrastructure for the security forces in Israel and abroad, as provided in its agreements with the defense forces. Bezeq is required to appoint a security officer and to comply fully with the security instructions contained with the applicable provisions in its license.
 
 
Supervision and reporting – The license imposes on Bezeq extensive reporting requirements to the Ministry of Communications. In addition, the Director General of the Ministry of Communications has the authority to enter the facilities and offices used by Bezeq and to seize documents.
 
 
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Miscellaneous –
 
 
o
The Carrier License includes limitations on the acquisition, maintenance and transfer of means of control pursuant to the Communications Order, as well as on cross-ownership, which are mainly a ban on cross-holdings by entities with an interest in another material domestic carrier, and limitations on cross-holdings by entities with Carrier Licenses or general licenses in the same segment of operation.
 
 
o
Bezeq is required to prepare a draft of any agreements it plans to offer to subscribers and to submit them for the review by the Director General upon demand. The Director General has the authority to instruct that changes be made. Bezeq is in the process of preparing such an agreement.
 
 
o
Pursuant to the requirement of the license, Bezeq submitted to the Director General a $10 million bank guarantee to secure its fulfillment of the terms of the license and to indemnify the State of Israel against any loss it may incur due to violations. The Minister may declare the guarantee or part of it forfeit based on the terms of the license.
 
 
o
The Director General has the power to impose a monetary sanction for violation of any of the terms of the license.
 
 
o
During a calendar year, Bezeq may invest up to 25% of its annual income in activities not connected with the provision of its services (the income of its subsidiaries is not considered income for this purpose). The Minister of Communications is authorized to grant a variance from that percentage.

Products and Services
 
Telephony
 
Bezeq's telephony services include basic telephony services on domestic telephone lines and associated services such as voice mail, caller ID, call waiting, call forwarding, speed dial, and conference calls. Bezeq also provides national services for businesses (1-800, 1-700) that offer full or partial payment for incoming calls by businesses. Bezeq currently operates approximately 12,500 public telephones around the country. As part of its marketing strategy, Bezeq is working on the development and launch of new services in both the private and business sectors. Bezeq plans to continue to launch additional products on the basis of market trends and customer needs.
 
Bezeq's telephony services are its principal business, and in recent years the use of and revenues from these services have decreased, mainly due to competition from other fixed-line telephony service providers and from cellular companies. The decrease in demand is reflected in the gradual decrease in the number of calls originating in the fixed-line networks. Bezeq believes that this trend is primarily due to the increase in the number of cellular subscribers and the volume of use of cellular telephones, the increasing popularity of comprehensive call minutes packages which the cellular companies have marketed extensively over the last year (Bezeq estimates that 75% of all calls originate on the cellular network), from voice-over-Internet calls and from competition with other domestic operators. As of December 31, 2012, Bezeq had 2,268,000 active fixed telephone lines compared with 2,367,000 active lines as of December 31, 2011, a decrease of 4%. The decrease was due in part to the elimination of the NDSL service and falling cellular prices. In addition, the number of call minutes (incoming and outgoing) on Bezeq's fixed telephone lines decreased by 7% in 2012 compared to 2011. Average monthly revenues per phone line decreased by approximately 4% in 2012 compared to 2011.
 
 
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The following chart illustrates changes in the number of fixed telephone lines compared with the number of cellular phone lines in Israel during the period of 1995 to 2012:
 
 
The figures are based on a Ministry of Communications publication on cellular lines, the reports of HOT to the public and assessments of the other operators. Accordingly, some of the data is based on estimates and the actual data might differ. Commencing in 2008, the calculation of fixed lines includes IP Centrex lines (lines in a virtual private exchange in a public network). For this purpose, the number of IP Centrex lines is measured by the maximum number of calls that can be made simultaneously.
 
The following chart illustrates changes in the number of call minutes from fixed telephone lines compared with the number of call minutes from cellular phone lines in Israel during the period of 1995 to 2012:
 
 
 
 
- 32 -

 
 
The data in the chart is based on Bezeq’s traffic data and assessments of the traffic of other operators in the market. Accordingly, some of the data in the figure is based on estimates and the actual data might differ.
 
Internet Access Infrastructure Services
 
The Internet market has been one of the fastest growing communication markets in recent years (although the growth in the number of subscribers has been at a slower rate than in the growth of demand for greater bandwidth) and this service has become a central focus for Bezeq’s investments in technology, marketing, advertising and customer acquisition and upgrades. In September 2009, Bezeq launched a gradual roll-out of a next generation network, or NGN, based on a core IP network and deployment of an optical fiber network to street cabinets, known as fiber to the curb, or FTTC.
 
As of December 31, 2012, Bezeq had 1,169,000 Internet subscribers compared with 1,111,000 subscribers as of December 31, 2011. As of December 31, 2012, Bezeq had substantially completed the full deployment of its NGN and the percentage of subscribers using NGN services (those with packages of 10 mbps or higher) was 62% of all of its subscribers connected to the NGN network (approximately 60% of all of Bezeq's Internet subscribers).
 
In 2012, an increase of approximately 5.2% was recorded in the number of Bezeq's Internet subscribers, and an increase of approximately 1.25% in the average monthly revenue per Internet subscriber, compared to 2011. The increase in revenues is attributable to the increase in the speeds offered in Bezeq surfing packages and the adoption of advanced services and value added applications.
 
The following chart illustrates changes in the number of internet lines and rate of growth in the Internet segment during the period of 2003 to 2012:

 
The data for 2003 to 2011 is based on Bezeq’s data and Hot’s reports to the public. The data for 2012 is based on Bezeq’s data and an assessment of the number of HOT’s active lines (HOT has not yet published its financial statements for 2012). Accordingly, some of the data is based on estimates and the actual data might differ.
 
 
- 33 -

 
 
The following chart illustrates changes in the surfing speeds of Bezeq’s Internet subscribers during the period of 2006 to 2012 (in Mbps at the end of each year):
 
 
Data Transmission and Communication Services
 
Data communications services are network services for point-to-point transfer of data, transfer of data between computers and various communications networks, services to connect communications networks to the Internet, and remote access services.
 
Transmission services are transfer services for electromagnetic signals or a series of bits between telecommunications facilities of a license-holder (excluding terminal equipment). Bezeq offers high speed transmission services to communications operators in a range of interfaces.
 
Other services
 
Services to communications operators. Bezeq provides services to other communications operators, including the cellular and international operators, HOT, NEP operators, ISPs, domestic operators, and Palestinian Authority communications providers. Bezeq’s services include infrastructure, infrastructure upgrades, connection to Bezeq's network, transmission, billing and collection, rental of space and provision of services in its rented properties.
 
Broadcasting services. Bezeq operates and maintains radio transmitters which are operated by radio stations and operators including, the Israel Broadcasting Corporation and the Israeli Defense Force Radio (Galei Zahal). Bezeq also operates DTT transmitters for the Second Authority for Television and Radio, or the Second Authority. Bezeq is responsible for the operation and maintenance of the transmitters, but not for the content of the broadcasts.
 
Contract work. Bezeq performs setup and operation work on networks and sub-networks for various customers such as the Ministry of Defense, HOT, radio and television broadcasting companies, cellular and international communication operators, local authorities, municipalities and government agencies. Bezeq and HOT have agreements for the provision of installation and maintenance services of cable networks, on Bezeq's infrastructure, from the starting point of those licensees’ operating center, up to the point of delivery at the entrance to subscribers’ homes. The connection and maintenance from these points to the subscribers’ homes is not Bezeq’s responsibility.
 
IP Centrex. The IP Centrex service is a virtual private exchange service.
 
Data Centers. Data Center service enables provision of a solution for customers from the aspects of backup and survivability.
 
144 Internet site (B144). A search engine for finding business and private telephone numbers.
 
Free WiFi service.  This service allows Bezeq’s customers to share a portion of their wireless bandwidth with other customers in return for the ability to browse outside of their homes.
 
In addition to its 144 information service, Bezeq  operates a unified telephone directory ( telephone code (1344))  established by the Ministry of Communications for fixed-line and cellular telephony operators, as well as a unified website which is free of charge. A "unified" directory service is an information service containing data on the subscribers of all the operators. Fixed-line and cellular telephony operators are obliged, under the terms of their licenses, to provide unified information services. The operation of this service is exempted from the need to obtain governmental cartel approval until July 27, 2014.
 
 
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The table below shows data for the distribution of Bezeq's revenues by principal product and service in its segment of operation:
 
 
 
2010
 
 
2011
 
 
2012
 
 
 
(in NIS millions)
 
                         
Revenues from fixed-line telephony
 
 
3,160
 
 
 
2,393
 
 
 
2,254
 
Percentage out of total Bezeq Group revenues
 
 
60.04
%
 
 
51.49
%
 
 
48.68
%
Revenues from Internet infrastructure services
 
 
977
 
 
 
1,092
 
 
 
1,166
 
Percentage out of total Bezeq Group revenues
 
 
18.56
%
 
 
23.49
%
 
 
25.18
%
Revenues from transmission and data communication services
 
 
882
 
 
 
931
 
 
 
976
 
Percentage out of total Bezeq Group revenues
 
 
16.76
%
 
 
20.03
%
 
 
21.07
%
Revenues from other services
 
 
244
 
 
 
232
 
 
 
234
 
Percentage out of total Bezeq Group revenues
 
 
4.64
%
 
 
4.99
%
 
 
5.07
%
Total revenues from domestic fixed-line communications services segment
 
 
5,263
 
 
 
4,648
 
 
 
4,630
 
 
Customers
 
Bezeq’s sales are divided into two main sectors: the private sector which accounts for approximately 59% of revenues and the business sector which accounts for approximately 41% of revenues. Bezeq is not dependent on any single customer or small number of customers, the loss of which would materially affect its operation, and there is no customer, which accounts for 10% or more of Bezeq's total revenue.
 
The following table provides Bezeq’s revenues from its private and business customer sectors during the three years ended December 31, 2012:
 
 
 
2010
 
 
2011
 
 
2012
 
 
 
(in NIS millions)
                         
Revenues from private customers
 
 
3,128
 
 
 
2,777
     
2,716
 
Revenues from business customers
 
 
2,134
 
 
 
1,871
     
1,914
 
Total revenues
 
 
5,263
 
 
 
4,648
     
4,630
 
 
Tariffs
 
Bezeq charges its fixed-line customers interconnect fees for calls originating in its network and terminating in the cellular networks, and pays the cellular operators the same amount for transferring call traffic from their networks to its network.
 
In Bezeq’s domestic communications segment, it charges its customers for interconnect fees originating in its network and terminating in the cellular networks, and pays the cellular operators the same amount for transferring call traffic in their networks.
 
On February 28, 2013, Bezeq received a hearing from the Ministry of Communications stating that it is considering a reduction of the interconnect fee for call completion on the network of a domestic fixed-line operator, including Bezeq. The maximum tariff, which would be the same at all times, would be NIS 0.0104 per minute (instead of NIS 0.0421 at peak hours and NIS 0.0232 during non-peak hours, without VAT). This change, which would reduce Bezeq’s interconnect revenues, could be offset on the Bezeq Group level by reducing the costs incurred by Bezeq and its subsidiaries for interconnect fees. Bezeq estimates that the impact of such a change in the tariff would not be material. Bezeq intends to file its response to the hearing.
 
The table below indicates the impact of the reduction in the interconnect tariffs on the interconnect revenues Bezeq received from its fixed-line domestic subscribers in the three years ended December 31, 2012 (in NIS millions):
 
 
 
2010
 
 
2011
 
 
2012
 
                         
Revenue, net
 
 
801
 
 
 
256
     
226
 
 
 
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Competition
 
Bezeq believes that at the end of 2012, its market share in the fixed-line telephony market was approximately 59% of the private sector and 75% of the business sector, compared with 63% in the private sector and 76% in the business sector, at the end of 2011.
 
Bezeq and HOT Telecom both own nationally-deployed fixed-line telephony infrastructure and they are engaged in lively competition which is reflected, among other things, in the marketing of service bundles combining Hot Internet infrastructure, telephony and cable television, and possibly cellular services as well,  aimed mainly at households. In addition, HOT markets telephony services to business customers.
 
Bezeq also has competition from license-holders for domestic fixed-line communications services, including VoB.  The implementation of a wholesale market is expected to increase the competition.
 
The penetration rate of cellular telephony in Israel is among the highest in the world.  Bezeq believes that the high level of penetration combined with the increase in the capacity of the cellular network along with technological improvements, low airtime rates on an international scale and large-scale bundles of minutes at fixed monthly prices have made cellular telephones a substitute for landline telephones. Bezeq believes that this trend is one of the reasons for the growing reduction in the number of telephone lines.
 
In 2012, competition in the cellular communications market in Israel continued to intensify with the launch of the operations of Golan Telecom (as a new infrastructure operator) and Hot Mobile's UMTS network, and to a lesser degree from the launch of other virtual cellular operators.  These developments led to a drop in prices and a higher rate of customer churn among the cellular providers. These developments aggravated the trend of lower average traffic per fixed-line and the growing rate of removal fixed-line telephone lines.
 
Partner and Cellcom also provide fixed-domestic fixed-line services through corporations they own, and they sell service bundles that combine fixed-line, cellular telephony and Internet services.
 
On November 21, 2012, the Ministry determined that VoB or VoC services (broadband telephony services provided by a virtual cellular operator) will be regulated through a general Domestic Carrier license or special license, as applicable.  The Ministry announced that it will publish an amendment to the general and special Domestic Carrier licenses which currently apply to VoB services. Bezeq believes that the marketing of VoC services as part of a Domestic Carrier license in telephony will increase competition and will enable telephony services to be provided at fixed-line call prices on the cellular network.
 
On April 5, 2012, the decision of the Ministry of Communications to cancel NDSL services became effective. Accordingly, Bezeq may not apply different ADSL pricing for subscribers who use the service together with telephony service and for subscribers who only use the ADSL service. Cancellation of the tariff led to a decrease in Bezeq's revenues from Internet infrastructure services (and indirectly to the loss of fixed telephone lines) and increased the pace of recruiting customers to the Internet infrastructure.
 
Bezeq's preparation and methods of coping with the intensifying competition in Israel
 
Bezeq deals with competition in domestic fixed-line telecommunications services in several ways. Bezeq launches new communications services, value added applications and product packages, and services, in order to broaden the scope of use of subscriber lines, to respond to customer needs and to strengthen its image of technological innovation. It invests in the enhancement and modernization of its infrastructure to enable it to provide advanced services and products for its subscribers. Beginning in 2010, upon receipt of the requisite permit, Bezeq started marketing joint products packages in the private sector and in May 2012 in the business sector, while broadening the range of offered services and offering packages that correspond to some of those offered by its competitors.
 
Bezeq has focused on the penetration of its high-speed NGN internet infrastructure and on increasing the number of its customers for the service, including by offering new applications for businesses. NGN enables the provision of advanced telephony applications, customer upgrades to higher speeds, and the creation of added value for the customer by means of broader consumption of content, leisure and entertainment applications. In addition, Bezeq is constantly seeking to improve the quality of its services and to maintain its customers.
 
Bezeq has simplified its tariff structure and offers its customers alternative payment packages, tracks and campaigns. It offers bundles of services which combine the services of the Bezeq Group's subsidiaries (excluding DBS).  Bezeq utilizes use-based packages and service tracks to in order to promote subscriptions to its telephony services. In selling services to its customers, Bezeq also sells terminal equipment (home networks), laptop computers, streamers, etc., as well as telephony terminal equipment, as a tool for competitive differentiation and to increase its revenues
 
Bezeq also focuses its investments in fixed assets for growth activities and in projects that result in reduced operating costs. Nevertheless, Bezeq's ability to reduce its expenses in the short and medium term is limited due to the structure of its costs, which are mainly fixed in the short and medium term. These costs include depreciation expenses and expenses related to wages and wage incidentals. In addition, Bezeq has operating expenses such as infrastructure maintenance and the lease and upkeep of buildings, which are also fixed in the short term.
 
 
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Positive and negative factors that affect the competitive status of Bezeq
 
The positive factors that affect Bezeq’s competitive status are:
 
 
·
Nationally deployed, quality infrastructure through which a range of services are provided;
 
 
·
Presence in most businesses and households;
 
 
·
Strong and familiar brand;
 
 
·
Technological innovation;
 
 
·
Strong capital structure and positive cash flows;
 
 
·
Broad service infrastructure and varied customer interfaces; and
 
 
·
Professional, experienced and skilled human resources.
 
Bezeq believes that various limitations imposed upon it by existing regulation, impede its ability to compete in its areas of operation. The main limitations in this context are the following:
 
 
·
Absence of tariff flexibility  - Bezeq is limited in its ability to grant discounts on its principal services and to offer different tariffs.
 
 
·
Regulatory structural separation.
 
 
·
Bezeq’s duty to provide universal service -Bezeq operates under an obligation to provide service to the entire public in Israel (universal service). Due to this obligation, Bezeq could be required to provide services in circumstances which are not financially viable (subject to the possibility of obtaining an exemption from an exemptions committee in extraordinary circumstances following the recommendations of the advisory committee and the Minister of Communications decision on this matter). This obligation is not imposed on the holders of special Domestic Carrier licenses, who can offer their services to the most profitable of Bezeq's customers, mainly business customers, who are a material source of Bezeq’s income.
 
 
·
Access deficit - Bezeq's telephony tariffs are determined in regulations established by the Minister of Communications in consultation with the Minister of Finance. As a result of a deliberate regulatory policy, the monthly usage tariff for a telephone line is set at a level that does not cover the cost involved in providing it. This deficit has been reduced over the years but still exists. The negative factor of this deficit is exacerbated by competitor’s use of Bezeq's infrastructure to supply their services.
 
 
·
Limitations in marketing joint service bundles of Bezeq and other Bezeq Group companies.
 
 
·
Fixed-line terminal equipment is technologically less advanced that the cellular terminal equipment. Accordingly, the range of advanced services that can be offered to fixed line customers is limited.
 
 
·
The creation of a wholesale market
 
Internet Infrastructure Market
 
While the Internet segment has grown in recent years in terms of the number of customers, the growth rate is slowing as a result of the saturation of the market.  The Internet segment is characterized by the continued demand for increased surfing speeds and by the adoption of advanced services and value added applications. In 2012, the number of Bezeq’s Internet subscribers rose by 5%, in part due to the elimination of the NDSL service, and average monthly revenue per Internet subscriber rose by approximately 1% compared to 2011. The increase in revenues is attributable to the higher bandwidths offered to subscribers.
 
 Bezeq believes that its market share in the Internet infrastructure market was approximately 60% at the end of 2012, compared to 59% at the end of 2011.  Bezeq faces significant competition from the HOT Group and the cellular operators. The Ministry of Communications’ policy requires Bezeq and HOT to provide ISPs with “open access” to their infrastructure.
 
 
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HOT is currently Bezeq’s principal competitor in the private sector.  HOT's Internet infrastructure is deployed in Israel nationwide and provides a range of communications services and interactive applications.  In December 2010, HOT-Net was granted an ISP license, subject to structural separation limitations between HOT-Net, HOT and HOT Telecom, and limitations on marketing joint service packages that include HOT-Net's Internet access. Among the limitations are an obligation to market service packages that correspond to competing ISPs and an obligation to sell the ISP services separately and on the same terms as they are sold when part of the package. The grant of the ISP license to HOT-Net has increased the level of competition in Internet access. The upgrade of the infrastructure and grant of an ISP license to HOT-Net are expected to increase the level of competition in Internet access and could also increase the number of HOT customers who subscribe to service packages.
 
The cellular companies have deepened their Internet activities on the cellular networks both in the private sector and in the business sector. Unlike the fixed-line communications segment (where the provision of access infrastructure services by HOT is separate from the provision of Internet access services by the ISP), cellular Internet service is provided as one unit. Surfing services are provided both from the cellular handset and through a cellular modem that connects laptop and desktop computers in combination with Internet access services.
 
Transmission and Data Communication Services
 
The companies operating in this field are Cellcom, Partner (which acquired the Med-1 operations), HOT, and Internet companies that also use leased infrastructures. To the best of Bezeq's knowledge, Cellcom has deployed and set up a transmission network, which it uses both for its own needs (instead of transmission services provided for it in the past by Bezeq) and for competition with Bezeq in the transmission and data communications market. Cellcom offers its customers a complete package of solutions that includes domestic telephony, data communication and cellular communication, using its own infrastructure and its own sales array. Partner also provides transmission and data communication services combined with telephony, for business customers.
 
Under the terms of its license, Bezeq is obliged to provide some of its communications services to the entire public in Israel. According to the Ministry of Communications interpretation of this and other provisions in the Carrier License regarding the provision of infrastructure services to license-holders, Bezeq is also obliged to provide infrastructure and transmission services to competing communications operators for services which compete with those of Bezeq. Bezeq is acting in accordance with the Ministry's interpretation.
 
Marketing
 
Bezeq has marketing, sales and service groups for both the private and business sectors, which include customer managers for the business sector, combined sales and service centers located throughout Israel, technical support centers for private and business customers and 15 points of sale and service (the Bezeq Store network) in Israel, as well as a virtual online shop.
 
Bezeq markets its fixed-line services mainly through mass media advertising and telesales centers, customer managers, and a system of independent dealers including ISPs, and outsourced points of sale.

Networks and Equipment
 
Bezeq’s property and equipment consist primarily of domestic telecommunications infrastructure, exchanges, various networks, real estate (land and buildings), computer systems, vehicles and office equipment.
 
The main equipment used by Bezeq are exchanges, copper cables, fiber optical cables, transmission equipment, data communication systems and equipment, servers, Internet modems and routers. Bezeq purchases most of the equipment needed for its communications infrastructure from Israeli companies affiliated with international communications equipment manufacturers. Hardware and software are purchased from a number of suppliers.
 
Next Generation Network
 
The demand for communications services in Israel and worldwide includes a demand for ever-increasing bandwidths and an advanced IP platform. In order to meet this demand, Bezeq at the end of 2009 started the gradual set-up of an NGN based on a core IP network and the deployment of an optical fiber network to street cabinet (known as fiber to the curb, or FTTC).
 
The NGN network is also based on an access network (a system which connects NEPs on the subscriber's premises with the network and engineering systems). The connection from the home to the access network is based on copper cables and optical cables connecting the access systems to the backbone (in a special conduit or over-ground network), and to a very limited degree through wireless systems. Subscribers utilize the service though the use of their terminal equipment (equipment which is installed on the subscriber's premises, e.g. the actual telephone, private exchanges, fax machines, modems, routers, etc.).
 
 
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In this network and using VDSL2 technology, bandwidth of up to 100 Mbps download speed can be provided, as well as innovative added value services. Other advantages of the NGN technology are simplification of the network structure and better management capability. Bezeq launched the NGN in September 2009. At the end of 2012, Bezeq had substantially completed its deployment of the NGN and a considerable number of its customers upgraded their surfing speeds to the newly available levels.
 
In August 2012, Bezeq decided to extend its optical fiber deployment so that the fibers will be as close as possible to its customers’ premises (FTTH/FTTB). This will facilitate the future provision of more advanced and broader-band communications services than those currently provided. In this context, a detailed plan for the project will be prepared. The project will be modular and Bezeq will review the scope and outline of the project, as well as the need for adjustments, on a regular basis. Bezeq intends to accelerate the deployment of optical fibers to the customers’ homes and residential buildings (FTTH/FTTB), so that it will have significant fiber optic coverage in 2013.  The pace of this deployment is expected to increase in the following years. Conversely, these developments that have enabled IP-based telephony services are one of the factors that have led to the decline in the consumption of Bezeq’s fixed-line telephony services.
 
Computing
 
Bezeq’s IT system supports four central areas: (i) marketing and customer management; (ii) information systems for engineering infrastructures of the telecommunications networks; (iii) information systems for management of Bezeq fixed-line resources; and (iv) company - wide systems.
 
Marketing and customer management. The system supports management of a database of Bezeq’s customers, service order management, management of follow-up of customer complaints, management of the sales and service process, application of the number portability plan, and billing. The billing array includes the production of phone bills to customers for services provided by Bezeq and for the services of other communications operators. The billing array also includes the management of accounting for transactions with other communications operators.
 
Information systems for the engineering infrastructures of the telecommunications networks. These systems support the planning, management, control and maintenance of engineering resources for the provision and assurance of the services.
 
Information systems for management of the Company's resources. These systems support the management, control and maintenance of the expense side of Bezeq’s activities, including, financial information (including budget and control), purchasing and stock processes, property, real estate, human resources, salary control, fleet management, company projects, etc.
 
Company-wide systems. Bezeq maintains large and complex computer information systems that support critical work processes and handle very large volumes of data. The array of information systems consist of a large number of systems, some of which are legacy systems which were developed many years ago and operate on mainframe computers, and more modern systems, whose applications were developed more recently and operate in open computerization environments. The systems support decision-making processes utilizing a data warehouse operated by Bezeq. Bezeq also operates a website which provides information about its services and enables the display of information about telephone bills, payment information and other services. Bezeq also maintains computerized office systems (e-mail, decision follow-up, etc.), and knowledge management systems.
 
Suppliers
 
During 2012, no supplier accounted for more than 5% of the Bezeq Group's total annual purchases, nor did any supplier account for more than 10% of total purchases in a specific segment of operation. Most of the equipment purchased by Bezeq for data communication, switching, transmission and radio systems have been specially modified or developed for its use and the ability to obtain support other than through the manufacturer is limited.
 
Bezeq believes that, in light of the importance of manufacturer support for certain of its systems, it may become dependent in the areas of public switching and metro transmission on Alcatel Group, represented in Israel by Alcatel Telecom Israel Ltd., Dialogic Networks (Israel) Ltd., which supplies Bezeq with migration exchanges for linking operators to Bezeq's switching network and Comverse, Inc., which supplies Bezeq with switching exchanges for end customers on the NGN network. Bezeq may also become dependent on: (i) the NGN of Adtran Holdings Ltd. and IEC, (ii) Oracle in the area of databases;(iii) EMC which supplies Bezeq with hardware solutions for back-up, recovery and archiving of systems and infrastructures; (iv) VMware which supplies Bezeq with infrastructure for the entire virtualization of its servers; and (v) on ECI Telecom which supplies Bezeq with systems for connecting Bezeq's network and business customers on the transmission network.
 
 
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Agreements with suppliers on which Bezeq may be dependent are generally long term and usually include a warranty period for a specified period, followed by another period of maintenance or support. Where necessary, Bezeq may enter into an agreement with a supplier for the supply of support and/or maintenance services for further periods. These agreements usually contain various forms of recourse for Bezeq should the supplier breach the agreement.
 
Property
 
Bezeq initially obtained its real estate assets from the State of Israel in 1984 and has acquired additional properties since then, including properties leased from third parties. Bezeq owns or has long term ownership rights in approximately 395 properties throughout Israel.  The total area for which Bezeq has full ownership rights or capitalized lease rights (including joint lease rights as described below) is 1,060,000 square meters of land, of which 270,000 square meters have been improved. Of the 395 properties, approximately 380 properties consisting of 980,000 square meters of land and improved properties of 220,000 square meters are used for communications purposes, with the remainder used for administrative purposes. Of the foregoing properties, 40 are jointly owned with the Ministry of Communications, the Israel Postal Co. Ltd, or both. Bezeq's rights to a substantial number of its real estate assets are not registered in the Israeli Lands Registry, and therefore they correspond to contractual rights. Bezeq is in the process of registering in its name those properties which can be registered in the Lands Registry.
 
In addition to the 395 properties referred to above, Bezeq holds approximately 60 properties in the Administered Territories, covering a total area of 9,300 square meters of land and approximately 1,500 square meters of improved space. There is no written regulation of the contractual rights for these properties, but Bezeq believes that this does not create a material exposure. The real estate assets are used by Bezeq for communications activities (exchanges, neighborhood rooms, broadcasting sites, etc.) and for other activities (offices, storage areas, etc.). Some of the properties are undeveloped or partially developed and can be used for other purposes.
 
Bezeq also leases approximately 290 properties consisting of 63,000 square meters (approximately 280 of these properties have improved space of approximately 9,400 square meters, which are used for communications purposes, while the rest are used for administrative purposes.
 
Bezeq also has rights to approximately 70,000 square meters, net of land in Sakia, Israel for warehouse and office use. Bezeq is in advanced stages of negotiation with the Israeli Lands Administration, or ILA, to obtain an authorization to prepare development plans for the area.
 
Bezeq has an interest (transition rights, etc.) in other real estate, including for the erection of transmitters and for laying cables. Bezeq also has at its disposal approximately 550 neighborhood rooms (for cables and installations used for neighborhood communications) having a total area of approximately 8,310 square meters. No written agreements exist as to the rights of usage for most of these rooms.
 
According to a settlement agreement entered into in 2004 between Bezeq, the ILA and the State of Israel, which concerns most of the real estate that was transferred to Bezeq pursuant to the 1984 asset transfer agreement with the State of Israel, the assets remaining in Bezeq's possession have the status of a capitalized lease and are subject to the execution of individual lease contracts (to date contracts have been signed for approximately 90 of the 205 properties for which contracts are required). The settlement agreement allows Bezeq to enter into transactions and to enhance the properties beyond the rights according to plans approved in the settlement agreement and it provides for a mechanism for payment to the ILA for such enhancements, if undertaken, at the rate of 51% of the increase in value of the property following the enhancement (less part of the amounts paid for a betterment levy, if paid). The settlement agreement also provides that 17 properties must be returned to the ILA. Bezeq has returned 15 of those properties and the two remaining properties will be returned after Bezeq receives substitute properties, as provided in the settlement agreement.
 
Following a review by Bezeq's management, Bezeq’s Board of Directors approved further sales of properties which are not currently utilized or which can be easily vacated without incurring significant expenses. The transition to the NGN allowed Bezeq to increase the efficiency of its network and to vacate and sell some of its real estate assets. The sale of real estate assets that are not active or that can easily be vacated without incurring significant expenses, if and when be sold, may generate NIS hundreds of millions of capital gains for Bezeq, before taxes. During 2012, Bezeq sold 13 properties for approximately NIS 118 million.
 
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Employees
 
The following table provides data relating to the number of persons employed by Bezeq as of December 31, 2011 and 2012:
 
 
 
Number of employees
 
Description of employment framework
 
 
2011
 
 
 
2012
 
                 
Senior managers excluded from application of the Company’s collective bargaining agreements
 
 
63
 
 
 
61
 
Permanent employees employed under collective agreements (without new permanent employees)
 
 
2,847
 
 
 
2,742
 
Permanent employees employed under collective agreements (new permanent employees)
 
 
437
 
 
 
596
 
Employees employed under personal agreements that are not part of the collective agreements
 
 
666
 
 
 
635
 
Employees employed under individual agreements on the terms of the collective agreement
 
 
44
 
 
 
26
 
Employees employed in accordance with the special collective agreement of December 2006, on an hourly basis
 
 
1,948
 
 
 
2,288
 
Employees employed under the special collective agreement of December 2006, on a monthly basis
 
 
1,071
 
 
 
1,074
 
Total
 
 
7,076
 
 
 
7,422
 
 
The increase in the number of employees in 2012, compared to 2011, is primarily the result of hiring service representatives and customer service technicians in order to improve the level of customer service.
 
Bezeq’s Board of Directors currently consists of 12 directors, including three external directors, two employee-directors and two “independent” directors pursuant to the Israeli Companies Law. In addition, senior management has 12 member representatives.  Our Chairman, Mr. Shaul Elovitch, also serves as Chairman of the Board of Directors of Bezeq.
 
On January 17, 2013, Bezeq’s chief executive officer announced that he was resigning as of April 14, 2013. On March 6, 2013, Bezeq’s Board of Directors approved the appointment of Ms. Stella Handler, a former chief executive officer of our company, as the new chief executive officer of Bezeq, as of April 14, 2013.
 
The members of senior management are employed under personal agreements which include, pension coverage, payment of bonuses based on targets, and additional retirement benefits. Bezeq also allots options to the members of senior management at its discretion.
 
Labor relations are regulated by the collective agreements between Bezeq, its workers’ representatives and the Histadrut, and by personal contracts. Additionally, expansion orders to certain general collective agreements apply to Bezeq employees, such as cost-of-living increment agreements.
 
In December 2006, a special collective agreement was signed between Bezeq, its workers’ representatives and the Histadrut, regulating the labor relations in Bezeq following the privatization of Bezeq. Under the agreement, all prior agreements, arrangements and traditional behavior in Bezeq, including the linkage of wages to the public sector, would continue to apply only to the veteran permanent employees. According to the agreement, any hiring of existing and future temporary workers is made on the basis of monthly/hourly wage agreements based on a wage model according to occupation, with high managerial flexibility. The agreement sets out limitations on certain kinds of future organizational changes and a mechanism of notification, negotiation and arbitration with the workers’ representatives in the event such organizational changes. The agreement also allowed Bezeq, at its discretion, to terminate the employment of 245 permanent employees in each of the years 2009 – 2013. Under the agreement, during the term of the agreement, two employee-directors will serve on the Board of Directors of Bezeq, to be proposed by the workers’ representatives. The employee-directors are not entitled to payment for their service as directors and do not participate in Board discussions of the terms of employment of senior employees.
 
On December 19, 2010, an amendment to Bezeq’s collective agreement, which will be in effect until December 31, 2015 (with an option for an extension until December 31, 2017) was entered into. Under the terms of the amendment:
 
 
Retirement arrangements under the collective agreement were extended to December 31, 2016. Under these retirement arrangements, Bezeq may, at its discretion, terminate the employment of up to 245 permanent employees in each of the years 2010 – 2016.
 
 
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"New Permanent Employees" will be entitled to reduced retirement compensation.
 
On December 4, 2011, Bezeq's Board of Directors approved the early retirement of 91 employees at a total cost of NIS 80 million. This retirement completed the early retirement plan for 2011 as well as early retirement on account of an option for employee retirement in 2012, based on the terms of the special collective agreement from December 2006 and amended in December 2010. On November 7, 2012, the Board of Directors of Bezeq approved an additional budget of NIS 16 million for the early retirement of 19 employees during 2012. This supplement is in addition to an expense of NIS 16 million which was recognized for updating the provision in 2012. During the course of 2012, 122 tenured employees retired from Bezeq, based on the early retirement plan.
 
Employee Training
 
Bezeq conducts in-house training (including through a communications college) by company employees, who are professional experts, and at times with outside assistance in all areas of its operations.  The training activities include professional certification in technology, sales, management, service and other areas. Bezeq also participates in funding university studies and courses at outside facilities for its employees.
 
Option Plans
 
Bezeq has two option plans settled in cash through a net exercise mechanism and a phantom option plan, settled in cash. All of the options that were granted are non-transferrable and each option grant will vest in three equal installments. The exercise prices are adjusted for changes in equity and distributions of dividends. Below are additional details as of December 31, 2012:
 
Name of plan
 
Number of options granted (before forfeitures)
(in thousands)
   
Number of options in circulation as at December 31, 2012
(in thousands)
   
Weighted average of exercise price as at December 31, 2012 (NIS)
   
Weighted average of remaining contractual life
 
Employee option plan of 2010
    69,495 (1)     66,938 (1)     5.16       3  
Option plan for senior managers and employees of the Group of 2007
    65,250       3,089       2.84       4.25  
Phantom options plan for senior officers in the Group granted in December 2010
    16,400       16,400       7.91       3  
 
 
(1)
Subsequent to the date of Bezeq’s financial reports for the year ended December 31, 2012 and until April 22, 2013, 406,000 Bezeq shares were issued pursuant to exercises of options under this plan.
 
PELEPHONE
 
General
 
Pelephone provides cellular communications services and sells and repairs terminal equipment. Pelephone’s revenues include revenue from cellular communications customers (payments for call minutes, regular subscriptions, value-added services and roaming services), revenue from the sale of terminal equipment and revenues from other communications providers with respect to terminal equipment services and interconnect fees.
 
The Cellular Market
 
In view of the intensified competition, during the course of 2012 the manner of pricing services in the cellular market changed significantly. Instead of charging customers for actual usage or communications packages which are limited to a certain level of use with additional charges for extra use, the cellular carriers moved to offering unlimited packages. The increased competition and change in the format of the communications packages has led to a significant decrease in average revenue per subscriber and higher churn rates. Average monthly revenue per subscriber dropped by 11.2% in 2012. During 2012, there was an increase in the average monthly minutes used per subscriber, an increase in the number of messages (SMS) sent and a significant increase in the use of data communications (DATA).
 
The new operators that own infrastructure, the reform in the import of handsets and regulatory changes have led to lower demand for handsets and the amount of cellular terminal equipment sold by the cellular operators. In 2012, Pelephone's revenues from terminal equipment amounted to NIS 1.2 billion, accounting for 27% of total revenues, as against NIS 1.9 billion, accounting for 34.4% of revenues in 2011. The decline in sales of terminal equipment led to a drop in the number of customers, in parallel to a decline in the volume of payments to suppliers of terminal equipment.
 
 
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The cellular market has been characterized by lower growth rates due to saturation of the market. The penetration rate as at December 31, 2012 was 126%.
 
The following table provides summary condensed financial information concerning Bezeq’s Pelephone cellular segment for the three years ended December 31, 2012:
 
 
 
2010
 
 
2011
 
 
2012
 
                         
Revenues from services (NIS millions)
 
 
4,550
 
 
 
3,637
     
3,261
 
Revenues from sale of terminal equipment (NIS millions)
 
 
1,182
 
 
 
1,911
     
1,207
 
Total revenue (NIS millions)
 
 
5,732
 
 
 
5,548
     
4,468
 
Operating profit (NIS millions)
 
 
1,383
 
 
 
1,360
     
892
 
Depreciation and amortization (NIS)
 
 
601
 
 
 
561
     
531
 
Operating profit plus depreciation (EBITDA) (NIS millions)
 
 
1,984
 
 
 
1,921
     
1,423
 
Net profit (NIS millions)
 
 
1,033
 
 
 
1,056
     
698
 
Cash flow from operating activities (NIS millions)
 
 
1,219
 
 
 
800
     
1,728
 
Payments for investments in property, plant and equipment and intangible assets (NIS millions)
 
 
397
 
 
 
382
     
381
 
Free cash flow (in NIS millions) (1)
 
 
822
 
 
 
418
     
1,347
 
Number of subscribers at the end of the period (thousands) (2) (7)
 
 
2,857
 
 
 
2,847
     
2,800
 
Average number of minutes per subscriber per month (MOU) (3) (7)
 
 
349
 
 
 
375
     
419
 
Average monthly revenue per subscriber (NIS) (ARPU) (4) (7)
 
 
135
 
 
 
107
     
95
 
Average monthly revenue per subscriber (NIS) (ARPU) (based on reduced interconnect tariffs) (5) (7)
 
 
111
 
 
 
107
     
95
 
Churn rate (6) (7)
 
 
15.3
%
 
 
22.9
%
   
22.4
%
 
(1)
Cash from operating activities less purchase of property, plant and equipment and intangible assets, net.
 
(2)
Subscriber data does not include subscribers connected to Pelephone services for six months or more but who are inactive. An inactive subscriber is one who in the past six months has not received or made at least one call or who has not paid for Pelephone services.
 
(3)
Average monthly use per subscriber (in minutes) is calculated by the average monthly total outgoing minutes and incoming minutes in the period, divided by the average number of subscribers in the same period.
 
(4)
Average monthly revenue per subscriber is calculated by dividing average monthly total revenues from cellular services, repair and other services in the period, by the average number of active subscribers in the same period. The revenue was calculated based on the interconnect tariffs in force for each period.
 
(5)
In view of the reduction in interconnect tariffs commencing January 1, 2011, average monthly revenue data per subscriber for all three years is based on the reduced interconnect tariffs, for comparison with the 2011 data.
 
(6)
The churn rate is calculated at the ratio of subscribers who disconnected from the company's services and subscribers who became inactive during the period, to the average number of active subscribers during the period.
 
(7)
Due to increased movement of subscribers to pre-paid tracks in the initial months after reduction of the exit penalties, Pelephone decided not to include subscribers who had made no outgoing calls during the fourth quarter in the number of active subscribers. As a result, Pelephone deducted 91,000 subscribers. These subscribers were deducted retrospectively from each quarter in which they were moved to the pre-paid tracks. Consequently, figures for subscribers, ARPU, MOU and churn rates were corrected retroactively in each quarter.
 
The competition in the sector increased in 2012 due to the entrance of new competitors and regulatory changes that simplified the mobility of subscribers between cellular companies. This led to a decrease in income and continued high churn rates. The churn rate was 22.9% in 2011 and 22.4% in 2012.
 
 
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Products and Services
 
Pelephone provides its subscribers with comprehensive services of voice transmission, transmission of text messages, data communications and advanced multimedia services. Pelephone also offers its customers a broad range of packages and tracks that combine various services.
 
The following describes the services that Pelephone provides for its customers:
 
 
·
Basic telephone services (voice) – including basic call services, call completion services and auxiliary services such as call waiting, call forwarding, voice mail, voice conference call and caller ID.
 
 
·
Browsing and data services – Internet browsing using a mobile device with maximum download speeds of 42 mbps. Pelephone also offers its customers Internet browsing by means of a cellular modem.
 
 
·
Messaging service – a service for sending and receiving SMS text messages and multimedia MMS messages.
 
 
·
Content services - Pelephone offers its customers content services such as information and entertainment services on Pelephone's Internet portal, navigating services, Super TV and musixmatch, which makes it possible to listen to a variety of music via cellphone and PC.
 
 
·
Roaming services – Pelephone provides roaming services based on agreements it has with cellular operators abroad, enabling it to use their networks.  Pelephone is able to offer its customers with handsets in that technology, roaming services using their personal handsets to countries all over the world, and also provides these customers with roaming coverage in 212 countries. Pelephone also provides incoming roaming services for the customers of foreign operators staying in Israel.
 
 
·
Repair services – Pelephone offers its customers a repair service for a monthly payment entitling the customer to a warranty for the cellular handset, or for a one-time payment at the time of repair. Pelephone provides its customers with these services, and in addition, it provides, as part of hosting agreements, basic telephone (voice) services, surfing and data communications services, sending and receiving text messages, and roaming services to other cellular operators (Hot Mobile and Rami Levy).
 
 
·
Handsets – Pelephone offers its customers various types of cellular telephone, on-board telephones and hands-free devices, as well as support for its range of services.
 
 
·
Pelephone also supplies its customers with modems, laptop computers and tablets for surfing the Internet through the Pelephone network.
 
Cellular technologies used by Pelephone
 
Technological developments in terminal equipment and the desire to widen the range and quality of the services offered to the customers compel the cellular operators to periodically upgrade their network technologies, mostly on Generation 3.5 UMTS/HSPA technology. Pelephone currently operates communications networks based on two main technologies:
 
 
·
UMTS/HSPA, a digital technology based on the GSM standard. This technology is widespread throughout the world and enables subscriber identification and the provision of service by means of a SIM card, which can be transferred from one handset to another. Among the advantages of this technology is its support for download speeds of up to 42 Mbps and upload speeds of up to 5.7 Mbps. This cellular communications network is Pelephone’s primary network.
 
 
·
CDMA, a digital technology, which is less widespread than UMTS/HSPA and in which subscriber identification is by the identification of details burned onto the terminal equipment rather than by means of a SIM card. Until 2009, the CDMA network was Pelephone's only network and it continues to operate nationwide. This network serves a limited number of subscribers who seldom use the network.  Since the UMTS/HSAP network was launched, Pelephone has sought to transfer existing subscribers from CDMA to UMTS/HSPA, and offers subscribers an upgrade of their handsets to connect to the new network. It is not increasing its investments in the CDMA network beyond the needs of current maintenance.
 
 
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The cellular communications market is dynamic and is characterized by frequent technological changes in all its areas of operation (handsets, network technology and value added services). These changes impact the segment of operation on a number of levels: technological developments in terminal equipment and the desire to widen the range and quality of the services offered to the customer require cellular operators to periodically upgrade their network technologies. Pelephone constantly reviews new technologies that come onto the market and the need to upgrade its existing network technologies, depending on competition and the economic viability of the investment.
 
LTE technology is a data transfer technology based on an Internet Protocol that can transfer data at higher speeds than the existing Generation 3.5 technology.  This technology is used by many operators around the world. In 2012, smartphones which support this technology were introduced into the Israeli market, including the iPhone 5. In March 2012, the Ministry of Communications published a work plan on this subject. As at reporting date there is no certainty as to the allocation of a frequency range for use of LTE technology.  Such a policy, as well as technological developments in this area, could have a significant effect on Pelephone.  Pelephone expects that during 2013, the Ministry of Communications will make progress on the proposed tender for allocating LTE frequencies and will allocate the frequencies.
 
The penetration of smartphones, cellular phones with integrated operating systems allowing the use of advanced applications, has led to a rise in the consumption of data transfer services while increasing the supply of alternative applications and services to the Pelephone products and services provided by other entities. Pelephone expects that as a result of the decrease in tariffs and the increase in the number of subscribers using smartphones, there will be greater use of data communications and the average number of minutes used per subscriber will increase. Technologies that enable voice telephony and Internet (data) services in a VoC network could compete with Pelephone's services and materially affect its operations in the future.
 
In 2013, Pelephone expects to continue to invest in its UMTS/HSPA network and solidify its position as the fastest, highest quality and most advanced network. Together with the investment in the network, Pelephone expects to launch and promote several services which will help increase its revenues and improve its image compared with competitors. These services include anti-virus, data storage and backup, music and video services and surfing packages for tablets and cellular modems (Netstick).
 
Pelephone's UMTS/HSPA infrastructure is based principally on two switch farms that are connected to more than 2,100 sites.  Subsequent to the launch of the UMTS/HSPA network, Pelephone expanded the network. Investments in 2013 are projected to be NIS 396 million, including continued significant enlargement of network capacity, consistent with its investment of NIS 381 million in 2012.
 
Pelephone paid approximately NIS 32 million in royalties for 2012, or 1.3% of its revenues subject to royalties. For 2011, Pelephone paid approximately NIS 48 million, or 1.75% of its revenues subject to royalties.
 
Standards
 
Pelephone conducts routine durability and quality control tests of its facilities.  Pelephone complies with the requirements of Israeli Standard ISO 9001, 2008 version for mobile radio telephone (cellular) services and it undergoes periodic inspections by the Standards Institute of Israel to confirm compliance with the standard. The current control and quality certifications (IQC) are valid through December 2013.  Once a year, an inspection is conducted to ensure that Pelephone's operations comply with the requirements of the standard. The last inspection was carried out in December 2012 and was successful.
 
The following table provides a breakdown of Pelephone’s revenues by product and service for the three years ended December 31, 2012:
 
 
 
2010
 
 
2011
 
 
2012
 
 
 
(in NIS millions)
 
                         
Revenue from services (1)
 
 
4,550
 
 
 
3,637
 
 
 
3,261
 
Percentage of total revenue
 
 
79.4
%
 
 
65.6
%
 
 
73.0
%
Revenue from terminal equipment
 
 
1,182
 
 
 
1,911
 
 
 
1,207
 
Percentage of total revenue
 
 
20.6
%
 
 
34.4
%
 
 
27.0
%
Total revenue
 
 
5,732
 
 
 
5,548
 
 
 
4,468
 
 
 
(1)
Revenue from services includes revenues from cellular services (airtime, usage fees, call completion fees, roaming fees, value added services and others), and revenues from repair services and warranty.
 
 
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Competition
 
Until 2012, four companies with a general license for the provision of cellular services operated in Israel's cellular communications market. During 2012, a number of other cellular operators began to operate. The entry of the new operators has led to intensified competition, resulting in higher churn rates among the existing operators, a significant decrease in tariffs and consequently a decrease in profits. Pelephone's principal competitors, Cellcom, Partner and Hot (since February 2012), also provide Internet access services (ISPs) and domestic communications, and they market diverse joint service packages.
 
During 2011, Hot Mobile and Golan Telecom won a tender to receive frequencies and licenses for cellular operators that own infrastructure.  Following a required deployment of a cellular network that initially covers 10% of the population of the State of Israel, the new operators are able to utilize the existing operator networks for a period of up to seven years (with a possible extension based on approval for three more years) based on the national roaming model. According to the tender, Hot Mobile and Golan Telecom are scheduled to pay NIS 710 million and NIS 360 million, respectively,  in license fees at the end of five years.  To guarantee payment of the license fees, the two new operators provided bank guarantees in favor of the Ministry of Communications in the amount of the above mentioned license fees.  Such license fees will be reduced by one seventh (approximately 14.3%) for every 1% market share accumulated in the private sector over a five-year period from the date of grant of the license. Accordingly, if a new operator is able to gain 7% of the private market it will not be required to pay any license fees. In May 2012, Golan Telecom and Hot Mobile launched their operations, which immediately caused intensified competition in the cellular market among all the cellular operators. After launching their operations, Golan Telecom and Hot Mobile offered customers cellular communications packages which were significantly cheaper than the packages offered by the incumbent cellular operators. Pelephone and the other cellular operators responded to this new competition by offering new packages that reflect a substantial decrease in revenue per subscriber.
 
In addition, following the government's decision to encourage competition in the cellular market, nine MVNO licenses were granted to virtual operators (cellular operators that do not own their own infrastructure and provide their services using the networks of the existing operators). To the best of Pelephone's knowledge, only three of the MVNO license holders actually provide services: Rami Levy, Hot Mobile, and Alon Cellular.
 
The table below shows, to the best of Pelephone's knowledge, the approximate numbers of subscribers of Pelephone and its competitors in 2011 and 2012 (in thousands of subscribers), not including virtual operators.
 
     
Pelephone
   
Partner
   
Cellcom
   
Golan Telecom (1)
   
Hot Mobile
   
Total in market
 
At Dec. 31, 2011
No. of subscribers (2)
    2,847       3,176       3,349       -       444       9,816  
 
Market share
    29.0 %     32.4 %     34.1 %     -       4.5 %        
At Sep. 30, 2012
No. of subscribers (2)
    2,839       3,042       3,338       110       687       10,016  
 
Market share
    28.3 %     30.4 %     33.3 %     1.1 %     6.9 %        
 
 
(1)
Since Golan Telecom is a private company, it does not publish data about numbers of subscribers. The numbers in the table are an assessment.
 
 
(2)
The numbers of subscribers are as at September 30, 2012 and December 31, 2011, based on the reports of Cellcom, Partner and Hot Mobile to the public. (Hot Mobile is now a private company and therefore its figures are based on estimates.)
 
The number of subscribers of the virtual operators (MVNOs) is estimated to be approximately 100,000 subscribers, or approximately 1% of all cellular subscribers, as at December 31, 2012.
 
In 2012, Partner launched a discount brand called 012 mobile, and Cellcom introduced a communications package offering a combination of cellular communications, fixed-line communications, Internet and international calls. Pelephone responded to this new competition by introducing similar new packages which reflect a substantial reduction in revenue per subscriber.
 
During the second quarter of 2012, Pelephone’s competitors offered "unlimited" communications packages for the first time. In these packages, the subscribers can pay fixed usage fees and receive unlimited use of the services in accordance with the terms of their plans. These packages are the principal packages currently being offered in the cellular market, alongside the basic packages which include low usage fees, if any, allowing customers to use the services up to a certain amount (with additional charge for over-usage).
 
 
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Pelephone expects these trends to continue in 2013, leading to a significant decrease in revenues and profitability. Pelephone is introducing streamlining measures in an effort to reduce the impact of these trends on its margins.  This intense competition has led to a higher churn rate and significantly lower prices for communications packages for hundreds of thousands of subscribers.
 
Positive and negative factors that affect the competitive status of Pelephone
 
The positive factors that affect Pelephone’s competitive status are:
 
 
·
A high quality cellular network with extensive deployment;
 
 
·
A high-speed, advanced cellular network;
 
 
·
A broad array of services and diverse service interfaces for customers, enabling a high grade of customer service;
 
 
·
A distribution network that is skilled in providing appropriate solutions for every type of customer, with a skilled staff;
 
 
·
Strong capital structure and positive cash flow; and
 
 
·
Use of the Pelephone network by other cellular operators.
 
The negative factors that affect Pelephone’s competitive status are:
 
 
·
As a subsidiary of Bezeq, Pelephone is subject to regulatory restrictions, which do not apply to its competitors,  with respect to its entry into other areas of operation and the expansion of its service bundle for customers;
 
 
·
Limitations relating to its joint activities with Bezeq, including the marketing of joint service bundles;
 
 
·
The frequencies available to Pelephone might not be suitable, in certain cases, to the application of new cellular technologies that are under development. This could impede Pelephone in applying new technologies and could also impact adversely on its competitive status with other license-holders who may have frequencies that are suitable for those technologies and Pelephone may encounter difficulties in obtaining new frequency allocations; and
 
 
·
A disadvantageous position in the pre-paid market (use of terminal equipment at lower cost), due to the absence of a range of low-cost terminal equipment that operate in the UMTS/HSPA network.
 
Critical success factors in Pelephone’s market position and the changes occurring in the market
 
Pelephone has addressed the strong competition in this sector by streamlining its operations and completing the nationwide deployment of an advanced and high-quality network. Pelephone seeks to retain its technological leadership by regular maintenance of the network to a high standard and significant and regular investments in the cellular infrastructure, both for quality coverage of the whole country, which is a basic condition for providing Pelephone's services, and in order to provide customers with the most advanced services by means of the most advanced infrastructure and technology. Another factor that has contributed to Pelephone’s success is its nationwide deployment of sales and service centers that provide efficient customer support and service.
 
The principal entry barriers to the cellular market are:
 
 
·
The high penetration rate in the cellular market;
 
 
·
The need for a cellular license, the allocation of frequencies, which involves high costs and the subjection of operations to the regulatory supervision that applies to the market;
 
 
·
The need for significant financial resources necessary to make substantial and ongoing investments in infrastructure resulting from frequent technological changes and advances; and
 
 
·
The difficulty in erecting radio sites due to regulatory limitations and public opposition.
 
 
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These entry barriers do not apply to virtual operators and new cellular operators that own infrastructure which benefit from considerable easements granted to them to enable entry into the segment.
 
The principal exit barriers to the cellular market are:
 
·      The large investments and the time required to recoup such investments; and
 
·      The commitment to provide services for customers arising from the terms of the cellular license and agreements made in accordance with those terms.
 
Customers
 
At the end of 2012, Pelephone had approximately 2.8 million subscribers.  The table below provides the revenues from Pelephone’s private and business customers in each of the three years ended December 31, 2012 (in NIS millions):
 
 
 
2010
 
 
2011
 
 
2012
 
                         
Revenues from private customers                                                                    
 
 
2,899
 
 
 
2,985
     
2,461
 
Revenues from business customers (1)                                                                    
 
 
2,833
 
 
 
2,563
     
2,007
 
Total revenue                                                                    
 
 
5,732
 
 
 
5,548
     
4,468
 
 
 
(1)
Revenues from business customers include revenue from hosting agreements which amounted to NIS 129 million in 2012.
 
In addition to Pelephone's end-user subscribers, Pelephone provides services subject to hosting agreements to other cellular operators that use Pelephone's network to provide services to their customers.
 
Pelephone has an agreement with the Accountant General in the Ministry of Finance to supply mobile telephone services to government ministries through February 2014.  Pelephone has an option to extend this agreement for two additional years. As of December 31, 2012, Pelephone was supplying end equipment and mobile telephone service to 106,000 subscribers in the framework of this agreement.
 
Tariffs
 
The interconnect fees (call and text message (SMS) completion fees collected by Pelephone from other operators) are fixed in the Interconnect Regulations, which set the interconnect tariffs to be paid to domestic carriers, as well as limitations on the interconnect tariffs to be paid to a cellular operator. The other tariffs collected by Pelephone from its customers are not controlled, but the types of payments it can collect from its subscribers and the mechanisms for setting regulated tariffs, are regulated in the license.  Commencing January 1, 2011, the interconnect tariffs were lowered significantly. The tariffs, which are denominated in agorot (100 agorot are equal to 1 NIS) are linked to an index (the base index being the average CPI for 2009), and both VAT and the rate of royalties applicable to cellular operators multiplied by the indexed interconnect tariff will be added.
 
Below are the interconnect tariffs in agorot for the cellular operators as of December 31 of each year, which do not include VAT and are calculated at the royalty rate agreed upon by the government and the Supreme Court:
 
 
 
2010
 
 
2011
 
 
2012
 
 
2013
 
 
From 2014 onwards
 
                                         
Call minute completion tariff
 
 
25.1
 
 
 
7.28
 
 
 
6.80
 
 
 
6.43
 
 
 
6.01
 
SMS (text) completion tariff
 
 
2.85
 
 
 
0.17
 
 
 
0.16
 
 
 
0.15
 
 
 
0.14