Company Quick10K Filing
Cellcom Israel
20-F 2019-12-31 Filed 2020-03-23
20-F 2018-12-31 Filed 2019-03-18
20-F 2017-12-31 Filed 2018-03-26
20-F 2016-12-31 Filed 2017-03-20
20-F 2015-12-31 Filed 2016-03-21
20-F 2014-12-31 Filed 2015-03-16
20-F 2013-12-31 Filed 2014-03-06
20-F 2012-12-31 Filed 2013-03-04
20-F 2011-12-31 Filed 2012-03-07
20-F 2010-12-31 Filed 2011-03-15
20-F 2009-12-31 Filed 2010-03-02

CEL 20F Annual Report

Item 17 O
Item 18 O
Part I
Item 1.	Identity of Directors, Senior Management and Advisors
Item 2.	Offer Statistics and Expected Timetable
Item 3.	Key Information
Item 4.	Information on The Company
Item 4A.	Unresolved Staff Comments
Item 5.	Operating and Financial Review and Prospects
Item 6.	Directors, Senior Management and Employees
Item 7.	Major Shareholders and Related Party Transactions
Item 8.	Financial Information
Item 9.	The Offer and Listing
Item 10.	Additional Information
Item 11.	Quantitative and Qualitative Disclosures About Market Risk
Item 12.	Description of Securities Other Than Equity Securities
Part II
Item 13.	Defaults, Dividend Arrearages and Delinquencies
Item 14.	Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15.	Controls and Procedures
Item 16A.	 Audit Committee Financial Expert
Item 16B.	 Code of Ethics
Item 16C.	 Principal Accountant Fees and Services
Item 16D.	Exemptions From The Listing Standards for Audit Committees
Item 16E.	Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F.	 Change in Registrant's Certifying Accountant
Item 16G.	 Corporate Governance
Item 16H.	 Mine Safety Disclosure
Part III
Item 17.	Financial Statements
Item 18.	Financial Statements
Item 19. 	Exhibits
Note 1 - Reporting Entity
Note 2 - Basis of Preparation
Note 2 - Basis of Preparation (Cont'D)
Note 3 - Significant Accounting Policies
Note 3 - Significant Accounting Policies (Cont'D)
Note 4 - Fair Value
Note 5 - Financial Risk Management
Note 5 - Financial Risk Management (Cont'D)
Note 6 - Operating Segments
Note 6 - Operating Segments (Cont'D)
Note 7 - Subsidiaries
Note 8 - Cash and Cash Equivalents
Note 9 - Trade and Other Receivables
Note 10 - Inventory
Note 11 - Property, Plant and Equipment, Net
Note 12 - Intangible Assets, Net
Note 12 - Intangible Assets, Net (Cont'D)
Note 13 - Trade Payables and Accrued Expenses
Note 14 - Provisions
Note 15 - Other Payables, Including Derivatives
Note 16 - Other Long-Term Liabilities
Note 17 - Debentures
Note 17 - Debentures (Cont'D)
Note 18 - Liability for Employee Rights Upon Retirement, Net
Note 19 - Capital and Reserves
Note 19 - Capital and Reserves (Cont'D)
Note 20 - Share-Based Payments
Note 20 - Share-Based Payments (Cont'D)
Note 21 - Financial Instruments
Note 21 - Financial Instruments (Cont'D)
Note 22 - Revenues
Note 23 - Cost of Revenues
Note 24 - Selling and Marketing Expenses
Note 25 - General and Administrative Expenses
Note 26 - Other Expenses
Note 27 - Financing Income and Expenses
Note 28 - Income Tax
Note 28 - Income Tax (Cont'D)
Note 29 - Operating Leases
Note 30 - Commitments
Note 30 - Commitments (Cont'D)
Note 31 - Contingent Liabilities
Note 31 - Contingent Liabilities (Cont'D)
Note 32 - Regulation and Legislation
Note 32 - Regulation and Legislation (Cont'D)
Note 33 - Related Parties
Note 33 - Related Parties (Cont'D)
EX-4.11 dp64285_ex0411.htm
EX-4.14 dp64285_ex0414.htm
EX-12.1 dp64285_ex1201.htm
EX-12.2 dp64285_ex1202.htm
EX-13.1 dp64285_ex1301.htm
EX-15 dp64285_ex1501.htm

Cellcom Israel Earnings 2015-12-31

Balance SheetIncome StatementCash Flow

20-F 1 dp64285_20f.htm FORM 20-F

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20–F

 

oREGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2015

 

OR

 

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                 to                                

 

OR

 

oSHELL 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 001-33271

 

CELLCOM ISRAEL LTD.
(Exact name of Registrant as specified in its charter
and translation of Registrant’s name into English)
 
ISRAEL
(Jurisdiction of incorporation or organization)
 
10 Hagavish Street, Netanya  4250708, Israel
(Address of principal executive offices)

 

Liat Menahemi Stadler, 972-52-9989595 (phone), 972-98607986 (fax), LIATME@cellcom.co.il, 10 Hagavish Street, Netanya 4250708, 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, par value NIS 0.01 per share New York Stock Exchange ("NYSE")

 

Securities registered or to be registered pursuant to Section 12(g) of the Act.

 

None
(Title of Class)

 

1
 

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

 

None
(Title of Class)

 

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.

 

As of December 31, 2015, the Registrant had outstanding 100,604,578 Ordinary Shares, par value NIS 0.01 per share.

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x  Yes o No

 

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.  o Yes x No

 

Indicate by check mark whether the Registrant 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 has been subject to such filing requirements for the past 90 days. x Yes o No

 

Indicate by check mark whether the Registrant (1) 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).  o Yes o No

 

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  x Accelerated filer  o Non-accelerated filer  o

 

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 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). o Yes x No

 

2
 

 
TABLE OF CONTENTS

 

    Page
PART I
Item 1. Identity of Directors, Senior Management and Advisers 5
Item 2. Offer Statistics and Expected Timetable 5
Item 3. Key Information 5
Item 4. Information on the Company 30
Item 4A. Unresolved Staff Comments 83
Item 5. Operating and Financial Review and Prospects 84
Item 6. Directors, Senior Management and Employees 115
Item 7. Major Shareholders and Related Party Transactions 143
Item 8. Financial Information 147
Item 9. The Offer and Listing 150
Item 10. Additional Information 152
Item 11. Quantitative and Qualitative Disclosures About Market Risk 167
Item 12. Description of Securities Other than Equity Securities 168
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies 168
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds 168
Item 15. Controls and Procedures 168
Item 16A. Audit Committee Financial Expert 170
Item 16B. Code of Ethics 170
Item 16C. Principal Accountant Fees and Services 170
Item 16D. Exemptions from the Listing Standards for Audit Committees 171
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers 171
Item 16F. Change In Registrant’s Certifying Accountant 171
Item 16G. Corporate Governance 171
Item 16H. Mine Safety Disclosure 172
PART III
Item 17. Financial Statements 172
Item 18. Financial Statements 172
Item 19. Exhibits 173
Financial Statements F-1

  

3

introduction

 

In this annual report, "Cellcom," the "Company," "we," "us" and "our" refer to Cellcom Israel Ltd. and its subsidiaries. The terms "NIS" refers to new Israeli shekel, and "dollar," "USD" or "$" refers to U.S. dollars.

 

Presentation of Financial and Share Information

 

We prepare our consolidated financial statements in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB").

 

Unless we indicate otherwise, U.S. dollar translations of the NIS amounts presented in this annual report are translated for the convenience of the reader using the rate of NIS 3.902 to $1.00, the representative rate of exchange as of December 31, 2015 as published by the Bank of Israel. The translation is for the convenience of the reader only, and it does not represent the fair value of the translated assets and liabilities.

 

Trademarks

 

We have proprietary rights to trademarks used in this annual report which are important to our business. We have omitted the "®" and "™" designations for certain trademarks, but nonetheless reserve all rights to them. Each trademark, trade name or service mark of any other company appearing in this annual report belongs to its respective holder.

 

Industry and Market Data

 

This annual report contains information about our market share, market position and industry data. Unless otherwise indicated, this statistical and other market information is based on statistics prepared by the Ministry of Communications of Israel, Brandman Marketing Research and Consultancy Institute, Sapio Research and Development, Geocartography Research Institute, Rotem, ABI research, LINX and Meida Shivuki C.I (survey institute). Industry publications generally state that the information they contain has been obtained from sources believed to be reliable, but the accuracy and completeness of such information is not guaranteed. We have not independently verified the accuracy of market data and industry forecasts contained in this annual report that were taken or derived from these industry publications.

 

Special Note Regarding Forward-Looking Statements

 

We have made statements under the captions "Item 3. Key Information - D - Risk Factors," "Item 4 – Information on the Company," "Item 5. Operating and Financial Review and Prospects," and in other sections of this annual report that are forward-looking statements. In some cases, you can identify these statements by forward-looking words such as "may," "might," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential" or "continue," the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include projections of our future financial performance, our anticipated growth strategies and anticipated trends in our business. These statements are only predictions based on our current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or

 

4

achievements expressed or implied by the forward-looking statements, including those factors discussed under the caption entitled "Item 3. Key Information - D. Risk Factors." You should specifically consider the numerous risks outlined under "Item 3. Key Information - D. Risk Factors."

 

Although we believe the expectations reflected in the forward-looking statements contained in this annual report are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. We assume no duty to update any of these forward-looking statements after the date of this annual report to conform our prior statements to actual results or revised expectations, except as otherwise required by law.

 

Part i

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A.SELECTED FINANCIAL DATA

 

You should read the following selected consolidated financial data in conjunction with the section of this annual report entitled "Item 5. Operating and Financial Review and Prospects" and our consolidated financial statements and the notes thereto included elsewhere in this annual report.

 

The selected data presented below under the captions "Income Statement Data" and "Balance Sheet Data" for, and as of the end of, each of the years in the five-year period ended December 31, 2015, are derived from the consolidated financial statements of Cellcom Israel Ltd. and subsidiaries, which financial statements have been audited by Somekh Chaikin, an independent registered public accounting firm and a member firm of KPMG International. The consolidated financial statements as of December 31, 2014 and 2015, and for each of the years in the three-year period ended December 31, 2015, and the report thereon, are included elsewhere in this annual report. The selected data should be read in conjunction with the consolidated financial statements, the related notes, and the independent registered public accounting firm’s report and the convenience translation of the consolidated financial

 

5

statements as of and for the year ended December 31, 2015 into U.S. dollars solely for the convenience of the reader.

 

On August 31, 2011, we completed the acquisition of 100% of the share capital of Netvision Ltd., or Netvision. Therefore, the consolidated results for the year ended December 31, 2011, included elsewhere in this annual report, include Netvision's results for the months of September through December 2011 only.

 

The information presented below under the caption "Other Data" contains information that partly is not derived from the financial statements.

 

For your convenience, the following tables also contain U.S. dollar translations of the NIS amounts presented at December 31, 2015, translated using the rate of NIS 3.902 to $1.00, the representative rate of exchange on December 31, 2015 as published by the Bank of Israel.

 

  Year Ended December 31,
   2011(1)  2012  2013  2014  2015  2015
  (In NIS millions, except where indicated otherwise)  (In US$ millions)

Income Statement Data: 

                  
Revenues    6,506    5,938    4,927    4,570    4,180    1,071 
Cost of revenues    3,408    3,463    2,990    2,727    2,763    708 
Selling and marketing expenses    990    865    717    672    620    159 
General and administrative expenses    685    629    570    463    465    119 
Other (income) expenses, net    1    (4)   (1)   46    22    6 
Operating income    1,422    985    651    662    310    79 
Financing expense, net    293    259    246    198    177    45 
Income tax    304    195    117    110    36    9 
Net income    825    531    288    354    97    25 
Basic earnings per share (in NIS)    8.28    5.34    2.89    3.51    0.95    0.24 
Diluted earnings per share (in NIS)    8.28    5.33    2.86    3.48    0.95    0.24 
Weighted average ordinary shares used in calculation of basic earnings per share (in shares)   99,476,671    99,481,487    99,495,525    99,924,306    100,589,458    100,589,458 
Weighted average ordinary shares used in calculation of diluted earnings per share (in shares)   99,511,433    99,609,722    100,319,724    100,706,282    100,589,530    100,589,530 
Other Data:                              
EBITDA(2)    2,167    1,753    1,335    1,282    872    223 
Capital expenditures    520    537    384    487    396    101 
Dividends declared per share    7.88    1.31    0.85    -    -    - 
Net cash from operating activities    1,332    1,641    1,556    1,557    836    214 
Net cash used in investing activities    (1,656)   (708)   (344)   (350)   (96)   (25)
Net cash from (used in) financing activities    715    (439)   (1,569)   (1,106)   (1,136)   (291)
Cellular Subscribers (in thousands)(3)    3,349    3,199    3,092    2,967    2,835    2,835 
Churn rate of cellular subscribers(4)    25.1%   31.5%   36.8%   44%   42%   42%
Cellular ARPU (in NIS)(5)
   106    88    78    72    65    17 

Balance Sheet Data: 

                              
Cash    920    1,414    1,057    1,158    761    195 
Working capital    679    1,232    1,082    837    625    161 
Total assets    8,557    8,787    7,579    7,240    6,278    1,609 
Total equity    187    500    710    1,092    1,185    304 

 

6
 
(1)The consolidated financial results for the year ended December 31, 2011 include the results of Netvision, our wholly owned subsidiary, for the months September through December 2011. We consummated the acquisition of Netvision on August 31, 2011.

 

(2)EBITDA is a non-IFRS measure and is defined as income before financing income (expenses), net; other income (expenses), net (excluding expense related to employee retirement plans); income tax; depreciation and amortization and share based payments. We present EBITDA as a supplemental performance measure because we believe that it facilitates operating performance comparisons from period to period and company to company by backing out potential differences caused by variations in capital structure (most particularly affecting our interest expense given our significant debt), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age of, and depreciation expenses associated with, fixed assets. EBITDA should not be considered in isolation or as a substitute for operating income or other statement of operations or cash flow data prepared in accordance with IFRS as a measure of our profitability or liquidity. EBITDA does not take into account our debt service requirements and other commitments, including capital expenditures, and, accordingly, is not necessarily indicative of amounts that may be available for discretionary uses. In addition, EBITDA, as presented in this annual report, may not be comparable to similarly titled measures reported by other companies due to differences in the way that these measures are calculated.

 

The following is a reconciliation of net income to EBITDA:

 

  Year Ended December 31,
   2011  2012  2013  2014  2015  2015
  (In NIS millions)  (In US$ millions)
Net income    825    531    288    354    97    25 
Financing expense, net    293    259    246    198    177    45 
Other expenses (income),net (excluding expense related to employee retirement plans);    1    (4)   (1)   7    (3)   (1)
Taxes on income    304    195    117    110    36    9 
Depreciation and amortization    738    765    676    610    562    144 
Share based payments   6    7    9    3    3    1 
EBITDA    2,167    1,753    1,335    1,282    872    223 

 

(3)Cellular subscriber data refers to active subscribers. We use a six-month method of calculating our cellular subscriber base, which means that we deduct subscribers from our subscriber base after six months of no revenue generation and activity on our network by or in relation to the post-paid subscribers, no revenue generating calls or SMS for pre-paid subscribers and no data usage or less than NIS 1 of accumulated revenues for M2M (machine to machine) subscribers. The six-month method is, to the best of our knowledge, consistent with the methodology used by other cellular providers in Israel. During the fourth quarter of 2011, we removed approximately 52,000 subscribers from our subscribers base, which included subscribers using our TDMA network who had not requested a transfer to our other networks following the shutdown of our TDMA network as of December 31, 2011, and subscribers who ceased using our services following a change to our policy which previously allowed subscribers to change from post to prepaid subscription as a result of the reduction of early termination fees in plans which include a commitment to a predefined period, or Early Termination Fees, in the cellular market in early 2011. These changes affected other key performance indicators. In the fourth quarter of 2012 we removed approximately 138,000 M2M subscribers from our subscriber base, following the addition of the above revenue generation criterion for M2M subscribers. This change had an immaterial effect on our ARPU for 2012. In the fourth quarter of 2013, we removed approximately 64,000 subscribers from our subscriber base, following a change to our prepaid subscribers counting mechanism. As a result of such change, we add a prepaid subscriber to our subscribers base only upon charging a prepaid card and remove them from our subscribers base after six months of no revenue generating calls or SMS. Following each of these changes, we have not restated prior subscriber data to conform with this change.

 

(4)Churn rate is defined as the total number of voluntary and involuntary permanent deactivations of cellular subscribers in a given period expressed as a percentage of the number of cellular subscribers at the beginning of the period. Involuntary permanent deactivations relate to cellular subscribers who have failed to pay their arrears for the period of six consecutive months. Voluntary permanent deactivations relate to cellular subscribers who terminated their use of our cellular services. Churn rate data is excluding the above mentioned removals of subscribers.

 

(5)Average monthly revenue per cellular subscriber (ARPU) is calculated by dividing revenues from cellular services for the period by the average number of cellular subscribers during the period and by dividing the result by the number of months in the period. Revenues from inbound roaming services and hosting services are included even though the number of cellular subscribers in the equation does not include the users of those roaming and hosting services. Inbound roaming services and hosting services are included because ARPU is meant to capture all service revenues generated by a cellular network. Revenues from repair services pursuant to a monthly subscription, or Subscription Repair Services are included because they represent recurring revenues generated by cellular subscribers, but revenues from sales of handsets (which for purposes of this report may include other types of cellular end user equipment, such as tablets), non-subscription repair services carried out on a random basis, or Random Repair Service and other services are not included. We and industry analysts treat ARPU as a key performance indicator of a cellular operator because it is the closest meaningful measure of the contribution to service revenues made by an average subscriber.

 

We have set out below the calculation of cellular ARPU for each of the periods presented:

 

7

 

  Year Ended December 31,
   2011  2012  2013  2014  2015  2015
  (In NIS millions, except number of subscribers and months)  (In US$ millions)
Revenues    6,506    5,938    4,927    4,570    4,180    1,071 
less revenues from equipment sales    1,747    1,356    942    1,005    1,048    269 
less other revenues*    484    1,125    1,034    941    869    223 
Revenues used in cellular ARPU calculation    4,275    3,457    2,951    2,624    2,263    580 
Average number of cellular subscribers    3,361,803    3,291,843    3,135,857    3,034,946    2,898,987    2,898,987 
Months during period    12    12    12    12    12    12 
Cellular ARPU (in NIS, per month)    106    88    78    72    65    17 

*Other revenues include revenues from other communications services such as ISP, transmission services, local and international landline services and repair services.

 

Exchange Rate Information

 

The following table shows, for each of the months indicated, the high and low exchange rates between the NIS and the U.S. dollar, expressed as NIS per U.S. dollar and based upon the daily representative rate of exchange as published by the Bank of Israel:

 

Month  High (NIS)  Low (NIS)
September 2015    3.949    3.863 
October 2015    3.923    3.816 
November 2015    3.921    3.867 
December 2015    3.905    3.855 
January 2016    3.983    3.902 
February 2016    3.964    3.871 

 

On March 18, 2016 the daily representative rate of exchange between the NIS and U.S. dollar as published by the Bank of Israel was NIS 3.857 to $1.00.

 

The following table shows, for periods indicated, the average exchange rate between the NIS and the U.S. dollar, expressed as NIS per U.S. dollar, calculated based on the average of the representative rates of exchange on the last day of each month during the relevant period as published by the Bank of Israel:

 

Year  Average (NIS)
2011   3.582
2012   3.844
2013   3.601
2014   3.593
2015   3.887

 

The effect of exchange rate fluctuations on our business and operations is discussed in "Item 11 - Quantitative and Qualitative Disclosures about Market Risk."

 

B.CAPITALIZATION AND INDEBTEDNESS

 

Not applicable.

 

8
C.REASONS FOR THE OFFER AND USE OF PROCEEDS

 

Not applicable.

 

D.RISK FACTORS

 

We believe that the occurrence of any one or some combination of the following factors could have a material adverse effect on our business, financial condition or results of operations.

 

Risks Related to our Business

 

We operate in a heavily regulated industry, which can harm our results of operations. In recent years, regulation in Israel has materially adversely affected our results.

 

A substantial part of our operations is subject to the Israeli Communications Law, 1982, the Israeli Wireless Telegraph Ordinance (New Version), 1972, the regulations promulgated thereunder and the licenses for the provision of different telecommunications services that we received from the Ministry of Communications in accordance with the Communications Law. The interpretation and implementation of the Communications Law, Wireless Telegraph Ordinance and regulations and the provisions of our general licenses, as well as our other licenses, are not certain and subject to change, and disagreements have arisen and may arise in the future between the Ministry of Communications, or MOC, and us. The Communications Law and regulations thereunder grant the Ministry of Communications extensive regulatory and supervisory authority with regard to our activities, as well as the authority to impose substantial sanctions in the event of a breach of our licenses or the applicable laws and regulations. Further, in the event that we materially violate the terms of our licenses, the Ministry of Communications has the authority to revoke them. Our operations are also subject to the regulatory and supervisory authority of other Israeli regulators which have the authority to impose criminal and administrative sanctions against us.

 

Our general cellular license is valid until February 2022. It may be extended for additional six-year periods upon our request to the Ministry of Communications and confirmation from the Ministry of Communications that we have complied with the provisions of our license and the applicable law, have continuously invested in the improvement of our service and network and have demonstrated the ability to do so in the future. Netvision's unified licenses (granted in July 2015 and amended in February 2016) under which Netvision is providing landline telephony services, internet connectivity services, or ISP, and international long distance services, or ILD, are valid until March 2026 and February 2022, respectively and may be extended for additional ten year periods, on terms similar to those provided in our cellular license. Our other licenses are also limited in time. Our licenses may not be extended when necessary, or, if extended, the extensions may be granted on terms that are not favorable to us. In addition, the Ministry of Communications has interpreted and may interpret our licenses and has modified and may modify our licenses without our consent and in a manner that could limit our freedom to conduct our business and harm our results of operations. Possible changes to our licenses and legislation which would require us to change our pricing plans and information systems frequently or on a timetable we cannot meet, can increase the risk of noncompliance with our licenses or violation of such legislation and our exposure to lawsuits and regulatory sanctions.

 

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Further, our business and results of operations could be materially and adversely affected by new legislation and decisions by regulators or the courts that:

 

·approve the annulment or further relaxation of the structural separation requirements imposed on the Bezeq communications group, given its monopolistic or duopolistic powers in all areas in which we compete, and also on the Hot communications group (though to a lesser degree, given that Hot already has substantial leniencies despite its monopolistic and duopolistic powers), more so if carried out before an effective landline wholesale market, which includes both telephony and infrastructure, is effected on both Bezeq's and Hot's infrastructure; do not set competition-inducing tariffs with respect to the wholesale services or set other unfavorable regulation with respect to the landline wholesale market. See also "- We face intense competition in all aspects of our business" below and "Item 4. Information on The Company – B. Business Overview "-Competition";

 

·award our competitors certain benefits and leniencies not available to us, including through waiving, easing or not enforcing requirements set in the licenses of mobile network operators, or MNOs, or not making similar demands or not imposing similar restrictions. See "Item 4. Information on the Company – B. Business Overview - Competition", and thereunder "-wireline", "-Government Regulations – Mobile Virtual Network Operators" and thereunder: "- Additional MNOs" and " – Landline" for additional details;

 

·do not renew our licenses or the allocation of our frequencies or limit our usage thereof or demand that we return frequencies allocated to us or not allow us to obtain additional frequencies, as such become necessary;

 

·impose new safety or health-related requirements;

 

·impose additional restrictions or requirements with respect to the construction and operation of cell sites or the networks, including in relation to site and network sharing or provide leniencies to our competitors;

 

·impose restrictions or demand we meet additional requirements on the provision of services or products we provide or regulate or otherwise intervene with the terms under which we advertise, market or provide them to our subscribers, including in respect of existing agreements;

 

·allow other operators to provide services previously provided only by us to our subscribers;

 

·set higher service standards or costly requirements relating to the service we provide our customers, both in relation to our network quality and coverage and our customer service;

 

·impose a stricter policy with respect to privacy protection, such as with regard to data protection, collection, amelioration, segmentation or usage of data, including for commercial activities by us or for the benefit of third parties; and

 

·impose regulation on our OTT TV services, including the requirement to finance original productions or imposing unfavorable terms for the usage of

 

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the Digital terrestrial television (DTT) broadcasting in Israel or applying such regulation to us and not to other OTT TV providers . See "- Item 4. Information on the Company – B. Business Overview – Government Regulations ― OTT TV".

 

See "Item 4. Information on the Company – B. Business Overview – Government Regulations ― Our Principal License" and "- Other Licenses".

 

If we fail to compensate for lost revenues, increased expenses (objectively or in comparison to our competitors) or additional investments resulting from past or future legislative or regulatory changes with alternative sources of income or otherwise, our results of operations may be materially adversely affected.

 

We face intense competition in all aspects of our business.

 

The Israeli telecommunications market is highly competitive in many of its elements, including the cellular and landline service markets. The competition level has increased substantially in recent years, following the entry of additional competitors and regulatory changes alleviating entry barriers and transfer barriers. In the last year, we entered both the TV market through our OTT TV service and the landline infrastructure market, through the landline wholesale market (VDSL). In the other markets we operate in and specifically in the cellular market, the intensified competition led to price competition, the adverse effects of which include a high churn rate and high subscriber acquisition costs, in addition to continued price erosion, all of which have ultimately led to a material decrease in revenues and profitability for us and other MNOs. The current level of competition in all the markets in which we operate and aggressive price plan offerings by our competitors are expected to continue. See also the "Competition" section under "Item 4. Information on the Company - B. Business Overview","-Netvision - Internet infrastructure and ISP Business" and "-Netvision - Telephony Business". Should the current level of competition and trends continue, it will continue to materially adversely affect our results of operations. Any of the following developments materializing in our market, may result in increased competition and a further materially reduced profitability for us:

 

·the agreement for the purchase of Golan Telecom Ltd., or Golan by us is not approved by the regulators, if it results in Golan's insolvency and increased efforts by the other operators to recruit Golan's subscribers. For additional details, see "Item 4. Information on the Company – B. Business Overview "- Agreement for the Purchase of Golan".

 

·tariffs maintained at their current level or decreasing even further, including as part of a bundle.

 

·an ineffective landline wholesale market, including due to the exclusion of telephony wholesale services, services provided not in line with the wholesale market criteria, unfavorable pricing harming our ability to provide competitive bundles and compete with the Hot and Bezeq groups or further escalation of the competition by Bezeq and Hot, given their dominance in the landline market, more so if the structural limitations on these groups are alleviated before an effective landline wholesale market is in effect. See "Item 4. Information on The Company –B. Business Overview – Government Regulations – Landline" for additional details.

 

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·annulment or further relaxation of the structural separation imposed on each of the Bezeq and Hot groups as it will provide the Bezeq and Hot groups a competitive advantage, given their dominance in the landline telephony and infrastructure markets and TV market. See "Item 4. Information on The Company –B. Business Overview – Government Regulations – Landline" for additional details.

 

·entrance of new competitors to any of the markets we operate in, or the entry of existing competitors to additional markets or segments where they are currently not or less active, or as a result of regulatory changes, allowing other operators to provide services currently provided only by us to our subscribers. See "Item 4. Information on The Company –B. Business Overview - Government Regulation –Other Licenses –Unified License" and "-Additional MNOs".

 

·the continued increased competition in the handsets market may result in decreased handset sales. See "Item 4. Information on The Company –B. Business Overview – Competition" for additional details.

 

We may not be able to obtain permits to construct and operate cell sites.

 

We depend on our network of cell sites to maintain and enhance network coverage for our subscribers. We also deploy and operate microwave sites as part of our transmission network. The construction and operation of these various facilities are highly regulated and require us to obtain various consents and permits.

 

We have experienced difficulties in obtaining some of these consents and permits, particularly in obtaining building permits for cell sites from local planning and building authorities. As of December 31, 2015, we operated a small portion of our cell sites without building permits or applicable exemptions and approximately 33%of our cell sites without building permits in reliance on an exemption from the requirement to obtain a building permit, mainly for radio access devices. Our reliance on the exemption for radio access devices had been challenged and is currently awaiting ruling by the Israeli Supreme Court. Under an interim order issued by the Supreme Court in September 2010, we are unable to rely on the exemption in cellular networks, other than to replace existing radio access devices in certain conditions, until regulations limiting such reliance are enacted or a different decision by the court is made.

 

Additionally, District Court rulings adopted a narrower interpretation of 'rooftops', to which the exemption may be applied.

 

We also rely on the exemption for our rooftop microwave sites and signal amplifiers (known as 'repeaters'). It is unclear whether other types of repeaters require a building permit.

 

In addition, we may be operating a significant number of our cell sites in a manner that is not fully compatible with the building permits issued for these cell sites which may, in some cases, also constitute grounds for termination of our lease agreements for those sites or claims for breach of such agreements.

 

Pursuant to the Israeli Non-Ionizing Radiation Law, 2006, the granting or renewal of an operating permit by the Commissioner of Environmental Radiation at the Ministry of Environmental Protection of Israel, or the Commissioner, for a cell site or other facility is

 

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subject to the receipt of a building permit or an exemption from such a permit. Should we fail to obtain building permits for our cell sites or other facilities, including in the event that our reliance upon an exemption from the requirement to obtain building permits for these cell sites and other facilities is found invalid, the Commissioner will not grant or renew our operating permits for those cell sites and other facilities. Since October 2007, the Commissioner will not grant or renew operating permits to radio access devices where the local planning and building committee’s engineer objected to our reliance upon the said exemption.

 

Certain proposed amendments to the Non-Ionizing Radiation Law and Regulations and the Planning and Building Law, propose setting additional restrictions in relation to the operation of cell sites and other facilities, such as setting larger distance requirements between cell sites locations and residences or certain institutions.

 

In June 2010, proposed changes to the Israeli National Zoning Plan 36, or the Plan, which regulates cell site construction and operation, were approved by the Israeli National Council for Planning and Building and submitted for the approval of the Government of Israel. The proposed changes, if approved, would place additional restrictions on the construction and operation of cell sites. Several local planning and building authorities are claiming that Israeli cellular operators may not receive building permits, in reliance on the current Plan, for cell sites operating in frequencies not specifically detailed in the frequencies charts attached to the Plan and have refused to provide a building permit in a number of cases. The proposed draft amendment to the Plan covers all new cell sites requiring a building permit, independently of the frequencies in which they operate. Most of our cell sites and many cell sites operated by other operators also operate in frequencies not specifically detailed in the Plan.

 

Operation of a cell site or other facility without a building permit, operating permit or not in accordance with the permits or other legal requirements may subject us and our officers and directors to criminal, administrative and civil liability, to eviction orders in respect of the cell sites in breach, revocation or suspension of the operating permit, as well as to withholding the grant of operating permits to additional cell sites or demolition orders. As a result, we may be required to relocate cell sites to less favorable locations or stop operation of cell sites.

 

If we are unable to obtain or rely on exemptions from obtaining or to renew building or other consents and permits for our existing cell sites or other facilities, or if any of the proposed changes noted above are adopted, it could adversely affect our existing network and its build-out, delay the deployment of our 4G network, negatively affect the extent, quality and capacity of our network coverage and our ability to continue to market our products and services effectively, all of which may have a material adverse effect on our results of operations and financial condition.

 

For additional details see "Item 4.B – Business Overview - Government Regulations - Permits for Cell Site Construction".

 

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We may be required to indemnify certain local planning and building committees in respect of claims against them.

 

Under the Israeli Planning and Building Law, 1965, by approving a building plan, local planning and building committees may be required to compensate for depreciation of properties included in or neighboring the approved plan.

 

As a precondition to obtaining a cell site construction permit from a planning and building committee, we are required to provide a letter to the committee indemnifying it for possible depreciation claims and have provided hundreds of such indemnification letters to local planning and building committees. Calls upon our indemnification letters may have a material adverse effect on our financial condition and results of operations. We may also decide to demolish or relocate existing cell sites to less favorable locations or not at all, due to the obligation to provide indemnification. As a result, our existing service may be impaired or the expansion of our network coverage could be limited.

 

Alleged health risks relating to non-ionizing radiation generated from cell sites and cellular devices may harm our prospects.

 

Handsets, accessories and various types of cell sites are known to be sources of non-ionizing radiation emissions and are the subject of an ongoing public debate and concern in Israel. While, to the best of our knowledge, the handsets that we market comply with the applicable legislation that relate to acceptable "specific absorption rate," or SAR, levels, we rely on the SAR levels published by the manufacturers of these handsets and do not perform independent inspections of the SAR levels of these handsets. As the manufacturers’ approvals refer to a prototype handset, we have no information as to the actual level of SAR of the handsets throughout the lifecycle of the handsets, including in the case of handset repair. See also "Item 4. Information on the Company – B. Business Overview - Government Regulations - Handsets". In July 2008, the Israeli Ministry of Health published recommendations to take precautionary measures when using cellular handsets, which has increased the concerns of the Israeli public. In May 2011, the International Agency for Research on Cancer, an agency of the World Health Organization, or WHO, issued a press release classifying radiofrequency electromagnetic fields as possibly carcinogenic to humans (Group 2B), based on an increased risk for glioma, a malignant type of brain cancer, associated with wireless phone use. In June 2011, the WHO publication noted that to date, no adverse health effects have been established as being caused by mobile phone use and while an increased risk of brain tumors is not established, the increasing use of mobile phones and the lack of data for mobile phone use over time periods longer than 15 years warrant further research of mobile phone use and brain cancer risk, particularly given recent popular use by younger people with potentially longer periods of exposure. However, in September 2014, the Israeli Ministry of Health updated the possibly carcinogenic to humans elements list in its site, according to the International Agency for Research on Cancer's classification. Moreover, increasing awareness of the possible risks of cellular phones usage, reducing usage thereof and introducing precautionary measures were the subject of several bills in recent years.

 

Health concerns regarding cell sites have caused us difficulties in obtaining permits for cell site construction and obtaining or renewing leases for cell sites and even resulted in unlawful sabotage of a small number of cell sites and prompted proposed legislation aimed at increasing the minimum distance permitted between cell sites and certain institutions. Formal positions adopted by various Israeli Ministries with respect to radiation safety, include the position (2009) that cell sites constructed pursuant to a building permit are preferable to

 

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radio access devices, that 4G services involve some increase in the level of non-ionizing radiation the public will be exposed to and therefore should have limited permitted usage and that utilizing a cellular network to provide advanced services that can be provided through a landline network is not justified in light of the preventive care principle set forth in the Israeli Non-Ionizing Radiation Law.

 

If health concerns regarding non-ionizing radiation increase further, or if adverse findings in studies of non-ionizing radiation are published, non-ionizing radiation levels are found to be higher than the standards set for handsets and cell sites, we may be subject to health-related claims for substantial sums. Consumers may also be discouraged from using cellular handsets and regulators may impose additional restrictions on the construction and operation of cell sites or handset and accessories marketing and usage. As a result, we may experience increased difficulty in constructing and operating cell sites and obtaining leases for new cell site locations or renewing leases for existing locations, or be exposed to property depreciation claims; and we may lose revenues due to decreasing usage of our services and be subject to increased regulatory costs. We have not obtained insurance for these potential claims. See "Item 8. Financial Information – A. Consolidated Statements and Other Financial Information – Legal Proceedings – Class Actions" for additional details on two class actions filed against us in that respect. An adverse outcome or settlement of any health-related litigation against us or any other provider of cellular services could have a material adverse effect on our results of operations, financial condition or prospects.

 

The unionizing of our employees may impede necessary organizational and personnel changes, result in increased costs or disruption to our operation.

 

In September 2013, we recognized the Histadrut, an Israeli labor union, as the union representing the Company's and Netvision's employees and in February 2015, we entered a collective employment agreement with the Company's employees' representatives and the Histadrut for a term of 3 years (2015-2017). The agreement defines employment policy and terms in various aspects, including payments to the employees and procedures relating to manning a position, change of place of employment and dismissal, including management and employees' representative respective authority with regards to each. As a result, our day-to-day operations and our ability to execute organizational and personnel changes is more limited, cumbersome, costly and lengthy, as reflected in the voluntary retirement plan carried out in 2014 and 2015, and requires more management attention, that would otherwise be available for our ongoing business. In January 2016, the Histradrut announced a labor dispute in the Company with respect to outsourcing and other employment issues. Although to date, we have not suffered any work stoppages or other disruptions to our operation, future disagreements with the employees' representatives may trigger an adverse impact on our services or customer service, changes may fail to be executed or be executed in a materially different way than planned, resulting in substantially lower savings than expected or requiring materially increased employment costs. Inability or limited ability to make organizational and personnel changes, as well as work stoppages or other disruption to our operations and limitations on management's discretion, may damage the efficiency and quality of our operations, and may lead to damage to our reputation, increased customer churn, loss of market share and reduced profitability.

 

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We are exposed to, and currently are engaged in, a variety of legal proceedings, including class action lawsuits.

 

We provide services to millions of subscribers on a daily basis. As a result of the scope and magnitude of our operations, as well as the multitude of pricing plans for stand-alone and bundles of services, the large amount of usage data our information systems need to process and record with relation to our subscribers according to their respective pricing plans (currently involving, in certain cases, both Cellcom and Netvision systems), the frequent and multiple changes to our operation and pricing plans due to regulatory changes or in response to the changing conditions in the markets in which we operate, and the involvement of thousands of sales and customer service representatives in the sale process and after sale contacts with our existing or prospective customers - all increasing the risk of discrepancies between a pricing plan and the information processed by our internal information systems occurring or inadequate information provided, despite our continued efforts to the contrary - we are subject to the risk of a large number of lawsuits, including class action suits by consumers and consumer organizations, with respect to billing and other practices, such as customer care practices, marketing, including mass media marketing as well as sending commercial messages to customers, data collection and usage practices, including for commercial purposes, offering practices of products and services, including third parties' products and services and practices related to the provision of such services to our customers, such as disclosure requirements. In addition, with respect to practices governed by our licenses or other regulation, we are also subject to the risk of monetary and other regulatory sanctions. See "We operate in a heavily regulated industry, which can harm our results of operations. In recent years, regulation in Israel has materially adversely affected our results" above. These actions are costly to defend and could result in significant judgments against us. Recent years were characterized by a substantial increase in the number of requests for certification of class actions filed and approved in Israel in general, and also against us, the greater involvement of consumer organizations (by filing such suits, opposing settlement agreements and advocating the filing of lawsuits) and the Advocate General (opposing settlement agreements). All of this increases our legal exposure and our legal costs in defending against such suits, which as a result may materially and adversely affect our financial results. This trend is expected to continue. In addition to two class actions approved against us in 2011 and 2013, we have entered into several settlement agreements, mostly for immaterial sums and are currently engaged in dozens of purported class action suits as a defendant, many of which are for substantial amounts. Should these requests to certify lawsuits against us as class actions are approved and succeed, this may have a material adverse effect on our financial results. For a summary of certain material legal proceedings against us, see "Item 8 – Financial Information - A. Consolidated Statements and Other Financial Information –Legal Proceedings".

 

Further, predefined damages (set forth in the Consumer Protection Law as of 2013) for a discrepancy from a customer's pricing plan, remedied after the customer complained, may aggregate to substantial amounts if paid to numerous customers on multiple occasions, more so if a bill aiming to impose substantially increased predefined damages for any discrepancy from the customer's pricing plan, proposed in 2014 by the Ministry of Communications, is adopted.

 

We employ thousands of employees and are therefore subject to the risk of employee lawsuits, including class action suits by employees.

 

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We are subject to the risk of intellectual property rights claims against us, in relation to our TV service and other content related services, including video, photographs, music, music-related or other content we purchase from third party content providers. These claims may require us to initiate or defend protracted and costly litigation, regardless of the merits of these claims. If any of these claims succeed, we may be forced to pay damages or may be required to obtain licenses for the infringing product or service, which, if in substantial sums, could harm our results of operations. If we cannot obtain all necessary licenses on commercially reasonable terms, we may be forced to stop using or selling the products and services. We may not have insurance coverage for these types of claims.

 

Our operations are dependent on complex technology and information systems.

 

Our operations are dependent on a number of complex technological systems. The offering of bundles of services by us and Netvision, following our merger, increased the number of complex technological systems involved in providing service to our customers and in the billing process of our customers, resulting in some cases in cumbersome procedures, inefficient usage of resources and lack of uniformity. The occurrence of malfunctions in such complex and ever changing and expanding systems is inevitable. In addition, we are considering implementing one Customer Relation Management, or CRM system for both companies, which may result in larger expenditures than anticipated, require significant management attention that would otherwise be available for our ongoing business, or lead to unforeseen operating difficulties and malfunctions, which may lead to loss of revenues, legal claims and regulatory sanctions. For additional details regarding our information systems agreements, see "Item 4. Information on the Company - B. Business Overview - Network and Technology - Information technology". A malfunction in any of our systems which severely impacts our ability to provide products and services to our customers or adequately bill them, may result in loss of revenues to us, may adversely impact our brand and service perception, and expose us to legal claims, all of which may adversely affect our results of operations.

 

Our operations are dependent on various information systems. We have experienced, and continue to experience, various forms of cyber attacks on a frequent basis. The unauthorized entry to or disruption of operation of these information systems, including due to cyber attacks, may result in damage to us and our customers. Such damages could include our inability to provide certain services without disruptions, if at all, our inability to bill for services rendered, loss of data to us and our customers or abuse of customers' data, all of which may expose us to legal claims and liabilities. Further, any successful attacks on Netvision's customers' information systems, protected by Netvision's data security products, may also expose Netvision to legal claims and liability.

 

There are certain restrictions in our licenses relating to the ownership of our shares. As a result of a change in control of IDB, we are currently not in compliance with the terms of our licenses.

 

Our cellular license restricts ownership of our ordinary shares and who can serve as our directors as follows:

 

·our founding shareholder, Discount Investment Corporation Ltd., or DIC (or its transferee or transferees, if approved in advance by the Ministry of Communications as "founding shareholders"), must own at least 26% of each of our means of control;

 

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·Israeli citizens and residents among our founding shareholders (or their approved transferees) must own at least 20% of our outstanding share capital and each of our other means of control (DIC has agreed to comply with this requirement);

 

·a majority of our directors must be Israeli citizens and residents;

 

·at least 20% of our directors must be appointed by Israeli citizens and residents among our founding shareholders; and

 

·we are required to have a committee of our Board of Directors that deals with matters relating to state security, which must be comprised of at least four directors (including an external director) having the requisite security clearance by Israel’s General Security Service.

 

If these requirements are not complied with, we could be found to be in breach of our license and our license could be changed, suspended or revoked.

 

As a result of a rights offering effected by IDB in February 2015 and the subsequent purchase of IDB shares previously indirectly held by Mr. Ben Moshe, one of IDB's controlling shareholders at the time, by corporations controlled by Mr. Elsztain, the other controlling shareholder in October 2015, the control of IDB and consequently indirectly of us, has changed and requires the approval of the Ministry of Communications, including in relation to the Israeli holding requirements included in our communications licenses since Mr. Elsztain is not an Israeli citizen and resident. We have filed a formal request with the Ministry of Communications for its approval of such changes, which includes a request to amend our communications licenses, including with regard to the Israeli holdings requirement set forth in such licenses and an extension period in order for us to comply with the updated provisions (which has not been granted yet). See "Item 7. Major Shareholders and Related Party Transactions – A. Major Shareholders." If our request is not granted and some other accommodation is not provided by the Ministry of Communications, we may face sanctions, which, according to the terms of our licenses, could include the suspension or revocation of our licenses.

 

In addition, our license provides that, without the approval of the Ministry of Communications, no person may acquire or dispose of shares representing 10% or more of our outstanding share capital. Further, our directors and officers and any holder of ordinary shares representing 5% or more of our outstanding share capital may not own 5% or more of Bezeq or any of our competitors or serve as a director or officer of such a company, subject to certain exceptions which require the prior approval of the Ministry of Communications.

 

To ensure that an unauthorized acquisition of our shares would not jeopardize our license, our articles of association provide that any shares acquired without approval required under our license will not be entitled to voting rights.

 

If our service is to be determined by the Israeli Government to be an "essential service", the Prime Minister and the Ministry of Communications could impose additional limitations including a heightened requirement of Israeli ownership of our ordinary shares.

 

Although our articles of association contain certain provisions that are aimed at reducing the risk that holdings or transfers of our ordinary shares will contravene our license, we cannot entirely control these and other matters required by our license, the violation of

 

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which could be a basis for suspending or revoking our license. Our other licenses and Netvision's licenses contain similar restrictions. See also "Item 4. Information on the Company – B. Business Overview – Government Regulations - Our Principal License" and "-Other Licenses" and "Item 4. Information on The Company – B. Business Overview – Netvision".

 

We may be adversely affected by the significant technological and other changes in the cellular communications industry.

 

The telecommunications market is known for rapid and significant technological changes and requires ongoing investments in advanced technologies in order to remain competitive. In recent years we have witnessed a growing demand for Internet, content and data through advanced third and fourth generation cellular phones, smartphones, modems, tablets and other devices using cellular data that resulted in a rapid and immense growth of data traffic on cellular networks and required cellular operators to upgrade their networks to accord such demand. Transfer of subscribers to unlimited packages of services and national roaming on our network, have contributed to the substantially growing demand for data traffic on our network, as well as to voice and text messages. We estimate that data traffic will continue to rapidly grow in the future. To meet the growing demand for cellular data traffic, we are required, among others, to continue our investment in our 4G network and upgrading our transmission network, to allow larger capacity and higher data speed rates. In addition, as in order to provide optimal performance, our LTE network requires additional frequencies to those allocated to us under the LTE frequencies tender (as the Ministry of Communications expects us to evacuate 12 1800MHz which were allocated to us for our 2G network, to be used by our LTE network), we are in the process of allocating additional 1800MHz to our LTE network, in areas where lower usage of our 2G network, together with advanced and modern equipment and software features, allows such allocation, with negligible adverse effect to our 2G network performance. Nonetheless, such limited quantity of frequencies may adversely affect our network performance, specifically if we cannot use the LTE frequencies allocated to Golan pursuant to our pending agreement to purchase Golan or additional frequencies under a network sharing agreement, as our 4G network will have 15MHz at most (similar to Pelephone's network, unless Pelephone enters a network sharing agreement), whereas Partner and Hot's 4G combined network enjoys 20MHz, which may harm our competitive stance.

 

If we cannot obtain or maintain favorable arrangements with foreign telecommunications operators, our services may be less attractive or less profitable.

 

We rely on agreements with cellular providers outside Israel to provide roaming capabilities to our cellular subscribers in many areas outside Israel. We cannot control or compel the improvement of the quality of the service that they provide and it may be inferior or less advanced than the service that we provide. Some of our competitors may be able to obtain lower roaming rates than we do because they may have larger call volumes or can use more favorable agreements of their overseas affiliates. If our competitors’ providers can deliver a higher quality, more advanced or a more cost effective roaming service, then subscribers may migrate to those competitors and our results of operation could be adversely affected, more so if the proposed amendment to our license, allowing other operators to provide roaming services to our subscribers, will be adopted.

 

Inbound roaming to our network is also influenced by our ability to maintain favorable roaming arrangements. The entry of additional UMTS providers has not only

 

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increased competition regarding outgoing roaming services but also increased competition on inbound roaming services. Additional operators or the abovementioned proposed amendment to our license, may increase such competition further.

 

In recent years, roaming tariffs for our subscribers have decreased. If roaming tariffs continue to decrease including as a result of the increasing competition or the changing regulation, this could adversely affect our profitability and results of operations.

 

We also rely on agreements with foreign carriers to provide ILD services by Netvision as well as its international voice hubbing (providing ILD services to foreign operators) services. The risks detailed above in relation to roaming services and possible effects of such risks, apply to Netvion's ILD and hubbing services as well. See "Item 4. Information on The Company – B. Business Overview – Netvision – Telephony Business".

 

Our substantial debt increases our exposure to market risks, may limit our ability to incur additional debt that may be necessary to fund our operations and could adversely affect our financial stability; regulatory change, market terms and our financial results may affect our possibilities to raise debt.

 

As of December 31, 2015, our total indebtedness was approximately NIS 3,788 million ($971 million), with our net debt at approximately NIS 2,747 million ($704 million). For additional details see "Item 5. Operating and Financial Review and Prospects. – B. Liquidity and Capital Resources – General". The indentures governing our debentures currently permit us to incur additional indebtedness (subject in some cases to certain limitations). Our substantial debt could adversely affect our financial condition by, among other things:

 

·increasing our vulnerability to adverse economic, industry or business conditions, including increases in the Israeli Consumer Prices Index, or CPI, as approximately NIS 2,821 million ($723 million) is CPI linked

 

·limiting our flexibility in planning for, or reacting to, changes in our industry and the economy in general;

 

·requiring us to dedicate a substantial portion of our cash flow from operations to service our debt, thus reducing the funds available for operations and future business development, as well as for dividend distribution; and

 

·limiting our ability to obtain, or resulting in less favorable terms and pricing for, additional financing to operate, develop and expand our business or for refinancing existing debt.

 

Following circulars of the Commissioner of Capital Markets, Insurance and Savings in the Ministry of Finance published on October 2010 and August 2013, instructing institutional investors to follow certain procedures and requirements before investing in non-governmental debentures our series F through I indentures include certain limitations and covenants, including a covenant not to issue additional debentures if it involves a rating downgrade, certain financial covenants, negative pledge, cross default, limitation on the distribution of dividends, obligation to pay additional interest in case of certain rating downgrades (which occurred under our series F and G debentures, in June 2013). For details regarding such limitations and covenants see "Item 5. Operating and Financial Review and Prospects. – B. Liquidity and Capital Resources – Debt Service". These limitations are

 

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expected to apply to any additional debt incurred by us. These procedures, limitations and covenants limit our freedom to conduct our business, may impose additional costs on us and may limit our ability to borrow additional debt from Israeli institutional investors as well as adversely affect the terms and price of such debt raising.

 

Since 2011, we suffered a significant decrease in our operating results, following certain regulatory changes, intensified competition and price erosion (see "Item 4. Information on the Company – B. Business Overview –Competition" and "-Additional MNOs"). In May 2012 and in June 2013, the rating of our debentures was downgraded due to increased leverage and competitive pressure. This and any further downgrade in our rating, and any adverse change in our financial results, including any increase in our net leverage (defined in our series F through I indentures and other credit facilities as the ratio of net debt to EBITDA during a period of 12 consecutive months, excluding onetime influences), may adversely affect the terms and price of debt raised, particularly through the issuance of debentures to institutional investors, which, given the limitation on the ability of Israeli banks to lend money to us pursuant to the "Guidelines for Sound Bank Administration" issued by the Israeli Supervisor of Banks (as we are a member of IDB’s group of borrowers), may limit our ability to obtain additional financing to operate, develop and expand our business or to refinance existing debt.

 

See also the law for the promotion of competition and the mitigation of concentration under "Risks Relating to Our Ordinary Shares - Recent Legislation in Israel affecting corporate conglomerates, could adversely affect us" below, which may adversely affect our possibilities of raising debt from Israeli institutional investors.

 

Our business results may be affected by currency fluctuations, by our currency hedging positions and by changes in the Israeli Consumer Price Index.

 

A portion of our cash payments are incurred in, or linked to, foreign currencies, mainly U.S. dollars. In particular, in 2013, 2014 and 2015, payments denominated in, or linked to, foreign currencies, mainly U.S. dollars, represented approximately 24%, 20% and 24%, respectively, of our total cash outflow (including payments of principal and interest on our debentures). These payments included capital expenditures, some cell site rental fees, payments for roaming services and to equipment suppliers including handset and set-top boxes and content purchasing agreements (for our OTT TV service) suppliers and part of our dividend payments. As almost all of our cash receipts are in NIS, any devaluation of the NIS against the foreign currencies in which we make payments, particularly the U.S. dollar, will increase the NIS cost of our foreign currency denominated or linked expenses and capital expenditures.

 

Furthermore, since the principal amount of and interest that we pay on our Series B, D, F and H debentures, are linked to the Israeli CPI, any increase in the Israeli CPI will increase our financing expenses and could adversely affect our results of operations. See "Item 5. Operating and Financial Review and Prospects – B. Liquidity and Capital Resources – Debt Service" for details.

 

We purchase derivative financial instruments in order to hedge part of the foreign currency risks, CPI risks deriving from our operations and indebtedness. Derivatives are initially recognized at fair value. Changes in the fair value are accounted for such that: Changes in the fair value of derivative hedging instruments designated as a cash flow hedge are recognized directly as a component of our shareholders’ equity to the extent that the

 

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hedge is effective. To the extent that the hedge is ineffective, changes in fair value are recognized in our income statement as the hedged item affects earnings. The amount recognized in shareholders’ equity is transferred to our income statement in the same period that the hedged item affects our earnings. Notwithstanding the above, hedge accounting is not applied to derivative instruments that economically hedge monetary assets and liabilities denominated in foreign currencies. Changes in the fair value of such derivatives are recognized through our income statement upon occurrence. These differences in the derivative instruments' designation could result in fluctuations in our reported net income on a quarterly basis.

 

We may not be able to fulfill our dividend policy in the future; implementation of our dividend policy will significantly reduce our future cash reserves.

 

In February 2006, we adopted a dividend policy targeting a payout ratio of at least 75% of our net income in each calendar year, subject to any applicable law, our license and contractual obligations and provided that such distribution would not be detrimental to our cash needs or to any plans approved by our Board of Directors. Our series F through I indentures and other credit facilities contain a covenant not to distribute more than 95% of the profits available for distribution according to the Israeli Companies Law 1999, or Companies Law, or Profits. Moreover, under such indentures and other credit facilities, if our net leverage (defined as the ratio of net debt to EBITDA during a period of 12 consecutive months, excluding certain one-time effects) exceeds 3.5:1, we may not distribute more than 85% of our Profits and if our net leverage exceeds 4.0:1, we may not distribute more than 70% of our Profits. For additional details see "Item 5. Operating and Financial Review and Prospects – B. Liquidity and Capital Resources – Debt Service". In addition, our license requires that we and our 10% or more shareholders maintain at least $200 million of combined shareholders’ equity. Dividend payments are not guaranteed and our Board of Directors may decide, in its absolute discretion, at any time and for any reason, not to pay dividends or to pay dividends at a ratio to net income that is less than that paid in the past. Since 2012 our board of directors declared a dividend for the first quarter of 2012 and third quarter of 2013 only, constituting 75% of our net income and part of our retained earnings from earlier periods, respectively, whereas for the other quarters of 2012 and 2013 and in 2014 and 2015, our board of directors chose not to declare dividends, given the intensified competition and its adverse effect on our results of operations and in order to strengthen our balance sheet. See "Item 8. Financial Information - A. Consolidated Statements and Other Financial Information - Dividend Policy".

 

Our dividend policy, to the extent implemented, will significantly reduce our future cash reserves and may adversely affect our ability to fund unexpected capital expenditures. As a result, we may be required to borrow additional money or raise capital by issuing equity securities, which may not be possible on attractive terms or at all.

 

If we are unable to fulfill our dividend policy, or pay dividends at levels anticipated by investors in our shares, the market price of our shares may be negatively affected and the value of our investors’ investment may be reduced.

 

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We rely on a limited number of suppliers for key equipment and services. We do not own our own infrastructure in the landline market and are dependent on infrastructure providers.

 

We depend upon a small number of suppliers to provide us with key equipment and services. For example, Nokia Solutions and Networks Israel, or NSN, provides our network system based on LTE technology and GSM/GPRS/EDGE technology, our UMTS/HSPA core system, part of our radio access network and related products and services, and our landline New Generation Network system, or NGN system; LM Ericsson Israel, or LM Ericsson, supplies part of our radio access network and related products and services based on UMTS/HSPA technology and our OTT TV services platform; Alcatel Lucent Israel Ltd., or Alcatel Lucent and Cisco Systems, Inc., or Cisco provide our Carrier Ethernet network and SDH equipment for our transmission network; and Be’eri Printers provides our printing supplies and invoices as well as the distribution, packaging and delivery of invoices and other mail to the postal service distribution centers. In addition, we lease a small portion of our transmission capacity from Bezeq, the incumbent landline operator. Our OTT TV services are further dependent on the Israeli Second Radio and Television authority, the authority responsible for linear channels of the Digital terrestrial television (DTT) broadcasting in Israel.

 

We are further dependent on infrastructure providers for our (including Netvision's) ISP, ILD, landline telephony (using Voice over Broadband, or VOB technology), broadband infrastructure (using the VDSL landline wholesale market) and OTT TV services. Those providers include Mediterranean Nautilus Ltd. and Mediterranean Nautilus (Israel) Ltd., or collectively Med Nautilus, which connects the Israeli internet network to the "entry points" of the global internet network, as well as Israeli telephony, via an underwater communications cable, and Bezeq and Hot, which provide broadband infrastructure in Israel. Since the launch of the landline wholesale market, we are dependent on Bezeq for the provision of our broadband infrastructure services as well. Should an effective telephony service be provided under the wholesale market and the wholesale market effectively apply to Hot as well, we would be dependent on them for such services as well. These suppliers have suffered labor disruptions, stoppages and slowdowns and may experience them in the future as well. See also "Item 4. Information on The Company – B. Business Overview – Netvision".

 

In general, if these suppliers fail to provide equipment or services to us that meet requisite quality standards or on a timely basis, or at unfavorable terms to us, we may be unable to provide services to our subscribers in an optimal manner until an alternative source, if one is available, can be found or the situation is rectified, which may harm our ability to compete and result in loss of customers and revenues or place our licenses at risk of revocation for failure to satisfy the required service standards and subject us to customers' lawsuits.

 

In addition, our cellular end-user equipment sales have been dominated in recent years by Apple and Samsung products, representing over half of our handset sales. See "Item 4. Information on the Company - B. Business Overview - Handsets" for additional details. Advanced Digital Broadcast S.A., or ADB, provides our set-top boxes for our OTT TV services and Altech Multimedia (Pty) Ltd., or Altech, will provide our set-top boxes in the near future. Vubiquity Management Ltd., or VU, provides us with international content and content operation services for our OTT TV services. Should any of these suppliers refuse to sell equipment or content, as applicable, to us, condition such sales on unfavorable terms and conditions or provide our competitors with more favorable terms and conditions, or if these

 

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suppliers fail to produce successful and desirable products or content when no equivalent alternatives are available, this could have a material adverse effect on our handset sales or OTT TV services revenues, as applicable, and results of operations. In addition, any regulatory change which will prevent our customers from using the DTT or condition such usage on unfavorable terms, degradation of service quality, or labor disputes may adversely affect our services, which may harm our ability to compete and result in loss of customers and revenues.

 

Our investment in new businesses involves many risks.

 

We have invested and expect to continue to invest in exploration and development of new business opportunities in order to extend and complete our capabilities and offerings, such as our OTT TV solution, which we launched in December 2014. Such endeavors may involve significant risks and uncertainties, including shift of management attention from our ongoing business, loss of focus of our sales and marketing efforts on our main businesses due to attention given to new businesses, insufficient revenues to offset liabilities assumed and expenses associated with these new investments, adversely affecting our cash flow, especially in businesses that require long term and fixed cost such as for the purchase of content in favor of our OTT TV services, inadequate return of capital on our investments, regulatory changes which may impose additional burdens than those planned, inability to effectively compete with incumbent providers or new competitors entering the market, and unidentified issues not discovered in our due diligence of such strategies and offerings, such as unforeseen operating difficulties and large expenditures. Because these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not materially adversely affect our reputation, financial condition, and operating results. Moreover, entry into such new ventures may trigger increased competitive pressure by the incumbent providers of competing services on our core business, aiming at preventing our efforts to compete with them at the relevant market, as triggered in December 2014 by Hot after the launch of our OTT TV services.

 

We are a member of the IDB group of companies, a large and highly regulated Israeli business group, which may limit our ability to expand our business, to acquire other businesses or raise debt. The effects on us of IDB's financial condition are unclear.

 

We are an indirect subsidiary of IDB Development Corporation Ltd., or IDB, large and highly regulated Israeli business group. In May 2014, a creditors' arrangement for IDB Holding Corporation Ltd., or IDB Holding, was consummated, and since the third quarter of 2014, IDB's financial statements include a note regarding the existence of significant doubts as to its ability to continue as a going concern due in part to its liquidity condition. In January 2016, the rating of IDB's debentures was further downgraded due to the rating agency's assessment of an additional erosion in IDB's liquidity profile and increase in the risk for insolvency. In March 2016, the rating of DIC's debentures was also further downgraded due to the rating agency's assessment of an insufficient improvement in the DIC's financial flexibility and relatively weak liquidity. IDB's and DIC's financial condition could have an adverse effect on our debentures rating, or on the terms of any new debt raised. In addition, pursuant to the "Guidelines for Sound Bank Administration" issued by the Israeli Supervisor of Banks, the amount that an Israeli bank may lend to one group of borrowers and to each of its six largest borrowers is limited. Since we are a member of IDB’s group of borrowers, these guidelines may limit the ability of Israeli banks to lend money to us.

 

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Under the Law for the Promotion of Competition and the Mitigation of Concentration, or the Concentration Law, competitive and control concentration factors, both of a certain market and generally, are to be taken into consideration prior to allocation of rights in public assets (including in the communications field) by the relevant governmental authorities, to entities considered to be 'concentrated entities'. Being a subsidiary of IDB, we were included in the list of concentrated entities published in December 2014 to which such requirements apply. This may adversely affect the renewal of our licenses and allocation of additional frequencies to us, which may have an adverse effect on our business. See also "Risks Relating to Our Ordinary Shares - Recent Legislation in Israel affecting corporate conglomerates, could adversely affect us" below.

 

Due to the limited size and high level of regulation of the Israeli market, and the communications market in particular, our being a member of the IDB group of companies may limit our ability to expand our business in the future, form joint ventures and strategic alliances and conduct other strategic transactions with other participants in the Israeli communications market. Specifically, it may hinder the approval of our agreement to purchase Golan.

 

We are controlled by a single shareholder who can significantly influence matters requiring shareholders’ approval.

 

As of December 31, 2015, Discount Investment Company, or DIC held, directly and indirectly, approximately 41.77% of our outstanding share capital. Pursuant to shareholders agreements among DIC and certain of our minority shareholders, who in the aggregate own approximately 3.39% of our ordinary shares, DIC has been granted the voting rights in respect of those shares. In addition to DIC’s shareholdings and such additional voting rights, it has the right to appoint the 20% of our directors that we are required by our license and articles of association to have appointed by Israeli citizens and residents among our founding shareholders. Accordingly, subject to legal limitations, DIC has control (as the term "control" is defined in the Israeli Securities Law; namely the ability to direct a company's activities) over all matters requiring shareholder approval, including the election and removal of our directors (other than external directors) and the approval of significant corporate transactions. This concentration of ownership could delay or prevent proxy contests, mergers, tender offers, open-market purchase programs or other purchases of our ordinary shares that might otherwise give our shareholders the opportunity to realize a premium over the then-prevailing market price for our ordinary shares.

 

Recent legislation in Israel affecting corporate conglomerates, could adversely affect us.

 

In December 2013, the Concentration Law was enacted by the Israeli parliament. The law, in material part: (1) imposes limitations on the holdings by a significant corporation that is not in the financial sector in a significant corporation in the financial sector or the holdings of both kinds of corporations under common control and on the possibility of serving as a director in both a significant non-financial corporation and a significant financial corporation; (2) imposes a two layer limitation on the total number of reporting corporations (layers) in pyramidal structure (for existing pyramidal structures of three layers - after a transition period of six years and of four layers – after a transition period of four years); (3) strengthens the corporate governance rules applicable to public companies in Israel, and sets additional limitations on certain transactions in which a controlling shareholder has a personal interest, strengthens the independence requirements of external directors and requires that as of September 2014 and during the said transition period in companies that are third layer and up

 

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in a pyramidal structure - the majority of the board of directors be independent, as defined in the Israeli Companies Law, and that the number of external directors be half the number of the company's directors less one (rounded upward) but not less than two; (4) authorizes the Israeli Minister of Finance or bodies authorized by it to set limitations regarding the aggregate credit that may be provided by financial institutions to a corporation or a business group (defined as a controlling shareholder and the corporations under its control); and (5) sets additional procedures including involving the committee of mitigation of concentration designated to take into consideration competitive and control concentration factors prior to any allocation of rights in public assets (including in the communications field) by the relevant governmental authorities. We are a third layer company in the pyramidal structure of the IDB group and were included in the list of concentrated entities published in December 2014 to whom such requirements apply. Accordingly, in September 2014 we changed the composition of our board of directors to accord with the requirements of the Concentration Law, and IDB and DIC have until December 2019 to cause us to cease being a third layer company. IDB and DIC have announced that they are reviewing possible ways to achieve this goal without having to forfeit control of us, such as by merging with each other or by taking IDB or DIC private. There can be no assurance how or when this would occur, if at all. In March 2016, IDB announced that the Israeli court approved an arrangement for the purchase of all of IDB's shares from the public by Dolphin Netherlands, pursuant to which companies indirectly controlled by Eduardo Elsztain will own all the shares of IDB as of the end of March 2016. However, since IDB's debentures will continue to be publicly traded, we will still be considered a third layer company. In addition, the new procedures set in the law in relation to allocation of rights in public assets, could have an adverse effect on our ability to renew our cellular license, receive additional frequencies or purchase Golan. The law may also adversely affect our ability to raise debt or other aspects of our business.

 

Risks Relating to Operating in Israel

 

We conduct our operations in Israel and therefore our results may be adversely affected by political, economic and military instability in Israel.

 

Our operations, our network and some of our suppliers are located in Israel. Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, Hamas (an Islamist militia and political group in the Gaza Strip) and Hezbollah (an Islamist militia and political group in Lebanon). Any hostilities involving Israel or the interruption or curtailment of trade within Israel or between Israel and its trading partners could adversely affect our operations and could make it more difficult for us to raise capital. A substantial part of our network and information systems is located within range of missile strikes from the Gaza Strip and Lebanon. Any damage to our network or information systems may damage our ability to provide service, in whole or in part or otherwise damage our operation and could have an adverse effect on our business, financial condition or results of operations.

 

More generally, any armed conflicts, terrorist activities or political instability in the region would likely negatively affect business conditions and could harm our results of operations, including following termination of such conflicts, due to a decrease in the number of tourists visiting Israel. Such adverse effects may also occur due to the increasing criticism of Israel in the international community. Since the end of 2010 several countries in the region, including Egypt and Syria, have been experiencing increased political instability, which led to changes in government in some of these countries, the effects of which are

 

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currently difficult to assess. The absence of a stable government in certain Middle Eastern countries has enabled the development of extremist groups, which could threaten Israeli interests. In addition, Iran has threatened to attack Israel and is suspected 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. This situation may potentially escalate in the future to violent events which may affect Israel and us.

 

In addition, in the event that the State of Israel relinquishes control over certain territories currently held by it to the Palestinian Authority, we will not be able to provide service from our cell sites located in Israeli populated areas and on connecting roads in these territories. This may result in the loss of subscribers and revenues and in a decrease in our market share.

 

Our freedom and ability to conduct our operations may be limited during periods of national emergency.

 

The Communications Law grants the Prime Minister of Israel the authority, for reasons of state security or public welfare, to order a telecommunications license holder to provide services to security forces, to perform telecommunications activities or to establish a telecommunications facility as may be required for the security forces to carry out their duties. Further, the Israeli Equipment Registration and IDF Mobilization Law, 1987, also permits the registration of engineering equipment and facilities and the taking thereof for the use of the Israel Defense Forces. This law further sets the payment for use and compensation for damages caused to the operator as a result of such taking. Our general license also permits the Israeli Government, during national emergencies or for reasons of national security, to take all necessary actions in order to ensure state security, including taking control of our network, and requires us to cooperate with such actions. If national emergency situations arise in the future and if we are to be subject during such time to any of the foregoing actions, this could adversely affect our ability to operate our business and provide services during such national emergencies and adversely affect our business operations. Our other licenses and Netvision's licenses (excluding our ISP licenses) contain similar restrictions. See also "Item 4. Information on the Company – B. Business Overview – Government Regulations ― Our Principal License", "Other Licenses" and "– Netvision".

 

Provisions of Israeli law and our license may delay, prevent or impede an acquisition of us, which could prevent a change of control.

 

The Israeli Companies 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. For example, a merger may not be completed unless at least 50 days have passed from the date that a merger proposal was filed by each merging company with the Israel Registrar of Companies and at least 30 days from the date that the shareholders of both merging companies approved the merger. In addition, a majority of each class of securities of the target company is required to approve a merger. Further, the provisions of our licenses require the prior approval of the Ministry of Communications for changes of control in our Company.

 

Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to our 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

 

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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 restricted. Moreover, with respect to certain 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 could delay, prevent or impede an acquisition of us, even if such an acquisition would be considered beneficial by some of our shareholders.

 

Risks Related to the Proposed acquisition of Golan Telecom Ltd.

 

Failure to consummate the acquisition could negatively impact the price of our ordinary shares and our future business and financial results.

 

In November 2015, we entered an agreement for the purchase of Golan, one of our competitors. The consummation of the acquisition may be delayed, the acquisition may be consummated on terms different than those contemplated by the purchase agreement, or the acquisition may not be consummated at all. In particular, we have not received regulatory approval for the acquisition of Golan. There is no assurance that the acquisition will be approved by the Israeli regulators and we anticipate that obtaining such approvals will be challenging, specifically in light of the strong opposition to the transaction, led by the Ministry of Treasury. The current market price of our ordinary shares may reflect a market uncertainty as to whether the acquisition will occur, and a failure to consummate the acquisition could result in a significant decline in the market price of our ordinary shares and a negative perception of us generally. Any delay in the consummation of the acquisition or any uncertainty about the consummation of the acquisition could also negatively impact our share price and future business and financial results.

 

Also, if the acquisition is not approved and we cannot maintain the national roaming revenues we currently enjoy or an equivalent compensation (with revenues from recruiting part of Golan's subscribers not being an adequate relief), it may substantially adversely affect our revenues and profitability and if such decision results in Golan's insolvency, we may face difficulties in the collection of Golan's debt to us. For additional details, see "Item 4. Information on the Company – B. Business Overview "- Agreement for the Purchase of Golan".

 

Failure to successfully execute or attain strategic objectives from our acquisition and growth strategy may adversely affect our financial condition and results of operations

 

Even if the acquisition is successfully executed, we may face subsequent difficulties in optimizing the operations of Golan and may experience unanticipated risks or liabilities that were not discovered, accurately disclosed or sufficiently assessed during the due diligence process. Moreover, even if Golan is successfully acquired, the business may ultimately fail or fall short of achieving our strategic objectives for the transaction over the long term.

 

Any failures in the execution of the transaction or in achieving our strategic objectives with respect to the acquisition could result in slower growth, higher than expected costs, the recording of asset impairment charges and other actions which could adversely affect our business, financial condition and results of operations.

 

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The proposed acquisition entails various risks, which include but are not limited to:

 

·the regulatory or other approvals required for the proposed acquisition may not be obtained, specifically in light of the strong opposition to the transaction, led by the Israeli Ministry of Treasury, or may be obtained subject to conditions that are not anticipated, or another condition to the closing of the proposed acquisition may not be satisfied, resulting in delays or ultimate failure of consummating a proposed acquisition;

 

·the lengthy, uncertain process of pursuing the purchase could disrupt relationships between us and Golan’s customers, suppliers and employees, distract our or Golan’s management from operating the business, and could lead to additional and unanticipated costs;

 

·the financing of the acquisition, if consummated, is expected to increase the level of our net debt and adversely affect the net debt to EBITDA ratio, included in our debentures and other credit facilities. See "Item 5. Operating and Financial Review and Prospects. – B. Liquidity and Capital Resources – Debt Service";

 

·Golan may be unable to retain and hire key personnel and/or maintain its relationships with customers, suppliers and other business partners pending the consummation of the proposed acquisition by us;

 

·after the consummation of the acquisition, we may be unable to retain Golan’s key personnel, existing customers, suppliers and other business partners or attract new customers;

 

·failure to achieve the targeted growth and expected benefits of the acquisition of Golan if sales of Golan’s services are lower than anticipated;

 

·undiscovered or unanticipated risks and liabilities, including legal and compliance related liabilities, may emerge in connection with the acquisition, or may be higher than anticipated; and

 

·even after successfully completing the acquisition, the anticipated benefits of the acquisition may ultimately prove to be less than anticipated.

 

For additional risks in relation to the Golan acquisition, see also "-We face intense competition in all aspects of our business" and "-We may be adversely affected by the significant technological and other changes in the cellular communications industry" above.

 

Risks Relating to Our Ordinary Shares

 

A substantial number of our ordinary shares could be sold into the public market, which could depress our share price.

 

Our largest shareholder, DIC, holds approximately 41.77% of our outstanding ordinary shares, as of December 31, 2015. The market price of our ordinary shares could decline as a result of future sales by DIC or other existing shareholders or the perception that these sales could occur. DIC sold approximately 5% of our outstanding shares outside the United States in 2011 and approximately 1.7% of our outstanding shares in 2013. In addition, under our recent agreement for the purchase of Golan, if approved and consummated, Golan's shareholders will be entitled to up to NIS 400 million in our shares (in accordance with a calculation mechanism set in the agreement), which they may sell after the lapse of two years from closing. See "Item 4. Information on the Company - B. Business Overview – General -

 

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Agreement for the Purchase of Golan". Sales may be made pursuant to a registration statement, filed with the U.S. Securities and Exchange Commission, or the SEC, pursuant to the terms of a registration rights agreement or otherwise, or in reliance on an exemption from the registration requirements of the Securities Act, including the exemptions provided by Rule 144. Any decline in our share price could also make it difficult for us to raise additional capital by selling shares.

 

In addition, under our 2006 option plan and 2015 option plan, options are subject to vesting schedules but vesting will be accelerated upon certain events, including any sale or other disposition, of all or substantially all, of the outstanding shares of us. As of December 31, 2015, we had 2,873,190 shares reserved for issuance upon the exercise of options. See "Item 6. Directors, Senior Management and Employment – E. Share Ownership – 2006 Share Incentive Plan".

 

ITEM 4. INFORMATION ON THE COMPANY

 

A.HISTORY AND DEVELOPMENT OF THE COMPANY

 

Our History

 

Cellcom Israel Ltd. was incorporated in 1994 in Israel. Our principal executive offices are located at 10 Hagavish Street, Netanya 4250708, Israel and our telephone number is (972)-52-999-0052. Our authorized U.S. representative, Puglisi & Associates, is located at 850 Library Avenue, Suite 204 Newark, Delaware 19711 and our agent for service of process in the United States, CT Corporation System, is located at 111 Eighth Avenue, New York, NY 10011.

 

In February 2007, we listed our shares on the NYSE and in July 2007, we dual listed our shares on the Tel Aviv Stock Exchange, or TASE, and began applying the reporting leniencies afforded under the Israeli Securities Law to companies whose securities are listed both on the NYSE and the TASE.

 

DIC, a subsidiary of IDB, currently directly and indirectly holds approximately 41.77% of our share capital and the voting rights in respect of an additional approximately 3.39% of our share capital.

 

As of the date of this Annual Report on Form 20-F, there has been no indication of any public takeover offer by any third party, in respect to our ordinary shares, or by us, with respect to another company’s shares.

 

We hold one of the five general licenses to provide cellular telephone services in Israel in addition to four MVNO providers. Our cellular license was granted by the Ministry of Communications in 1994 and is valid until 2022.

 

On August 31, 2011, we completed the acquisition of 100% of the share capital of Netvision, a major Israeli ISP and ILD services provider, for a total consideration of approximately NIS 1.57 billion ($404 million). Since prior to the merger transaction, the IDB Group controlled both Netvision and us, the merger transaction was approved as a related party transaction under Israeli law. For further details, see Item 7. B "Related Party Transactions". For further details on Netvision, see "Item 4.B -Business Overview - Netvision".

 

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Since 2012 we have suffered radical adverse changes to our results of operations, following regulatory changes, which also facilitated the entry of additional competitors, a dramatically increased competition and continued price erosion, resulting in a decrease in our EBITDA for 2012, 2013, 2014 and 2015 by 19.1%, 23.8%, 4.0% and 32%, respectively, in comparison to the previous year, despite continued implementation of aggressive efficiency measures in order to mitigate those adverse effects,. We intend to continue to implement organizational and personnel changes in our continued effort to mitigate the adverse effects of the increased competition in all areas in which operate. We cannot guarantee the success of these measures.

 

In December 2014 and May 2015, we entered the TV and internet infrastructure markets, respectively, which completed our communications offering to include all communications services in Israel.

 

In June 2015, we entered an agreement to purchase Home Cellular Ltd., one of the four MVNO's operating in the Israeli cellular market, for an immaterial sum. The agreement is subject to the approval of the Ministry of Communication.

 

In November 2015, we entered an agreement for the purchase of Golan, one of the other four MNO's operating in Israel. If approved by the regulators and consummated, we expect our purchase of Golan to, among other benefits, increase our cellular subscriber market share and our revenues, provide us with opportunities to offer our other services and products to Golan's subscribers and provide opportunities for cost synergies. See Item 3. Key Information – D. Risk Factors – Risks Related to our Business - We face intense competition in all aspects of our business" and "Item 4. Information on the Company - B. Business Overview – General - Agreement for the Purchase of Golan" and "-Competition" for additional details.

 

Principal Capital Expenditures

 

Our accrual capital expenditure in 2013, 2014 and 2015 amounted to NIS 384 million, NIS 487 million and NIS 396 million, respectively. Accrual capital expenditure is defined as investment in fixed assets and intangible assets, such as spectrum licenses, rights of use of communications lines, cellular networks' enhancement and expansion and development of new products, set-top boxes for our TV services and routers for our landline services.

 

B.BUSINESS OVERVIEW

 

General

 

We are the largest provider of cellular communications services in Israel based upon number of subscribers and estimated market share as of December 31, 2015. Upon launch of our services in 1994, we offered significantly lower prices for cellular communications services than the incumbent provider and transformed the nature of cellular telephone usage in Israel, turning it into a mass market consumption item. We surpassed the incumbent cellular operator and became the market leader in terms of number of subscribers in 1998 and, despite the entry of additional competitors, we have continued since then to have the highest number of subscribers. As of December 31, 2015, we provided services to approximately 2.835 million subscribers in Israel with an estimated market share of 27%. Our closest competitors – Partner and Pelephone - had estimated market shares of 26% and 25%, respectively. Hot Mobile was estimated to have a market share of 11.6%, Golan was

 

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estimated to have a market share of 8.5% and the MVNOs together, were estimated to have a market share of 1.6%. These estimates are based on the public reports of other operators and our estimate of the market share of the operators who do not publish reports.In the year ended December 31, 2015, we generated revenues of NIS 4,180 million ($1,071 million), EBITDA of NIS 872 million ($223 million), and operating income of NIS 310 million ($79 million). See note 2 to the table in "Item 3. Key Information – A. Selected Financial Data" for a definition of EBITDA. Since 2012 our results of operations were adversely affected by the increasing competition which led to accelerated price erosion and increased churn rate. We estimate that the intensified competition will continue to adversely affect our results in the future. See "Item 5. Operating and Financial Review and Prospects. – A. Operating Results – Overview –General ". We sell our various services on a stand-alone basis or bundled with certain other services offered by Netvision and us.

 

We offer a broad range of cellular services through our 2G and 3G cellular networks covering substantially all of the populated territory of Israel and our 4G network launched in 2014 and covering most of the population of Israel. These services include basic and advanced cellular telephone services, text and multimedia messaging services and advanced cellular content and data services. We also offer international roaming services in 181 countries as of December 31, 2015. We offer our subscribers a wide selection of handsets from various leading global manufacturers, as well as repair services on most handsets we offer. We also offer landline transmission and data services to business customers and telecommunications operators and, since July 2006, we offer landline telephony services. Since December 2014 we also offer OTT TV services and since February 2015 we (and Netvision) offer internet infrastructure services through the landline wholesale market (bundled with Netvision's ISP service or – more recently - through triple play packages which also include OTT TV services and VOB).

 

Through our wholly owned subsidiary Netvision, we offer ISP, ILD, landline telephony (VOB) and teleconferencing services. Additional services include cloud services and data protection products solutions based on products and services offered by us and by third party vendors. For further details on Netvision's business and operations, see "- Netvision" below.

 

In November 2015, we entered an agreement with Golan and its shareholders for the purchase of 100% of the shares of Golan for the sum of NIS 1.17 billion (subject to certain adjustments). The agreement is subject to certain conditions including the receipt of regulatory approvals. For additional details see " –Agreement for the Purchase of Golan" below.

 

The following table presents our number of cellular subscribers and revenues for each of the last five years:

 

   Year Ended December 31,
   2011  2012  2013  2014  2015
Cellular subscribers (end of period) (in thousands)(1)    3,349    3,199    3,092    2,967    2,835 
Revenues (in NIS millions)    6,506    5,938    4,927    4,570    4,180 

 

 
(1)Subscriber data refers to active cellular subscribers. We use a six-month method of calculating our cellular subscriber base, which means that we deduct subscribers from our cellular subscriber base after six months of no revenue generation and activity on our network by or in relation to the post-paid subscriber, no revenue generating calls or SMS for pre-paid subscriber and no data usage or

 

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less than NIS 1 of accumulated revenues for M2M (machine to machine) subscribers. The six-month method is, to the best of our knowledge, consistent with the methodology used by other cellular providers in Israel. During the fourth quarter of 2011, we removed approximately 52,000 subscribers from our subscribers base, which included subscribers using our TDMA network who had not requested a transfer to our other networks following the shutdown of our TDMA network as of December 31, 2011, and subscribers who ceased using our services following a change to our policy which previously allowed subscribers to change from post to prepaid subscription as a result of the reduction of Early Termination Fees in the cellular market in early 2011. These changes affected other key performance indicators. In the fourth quarter of 2012, we removed approximately 138,000 M2M subscribers from our subscriber base, following the addition of the above revenue generation criterion for M2M subscribers. This change had an immaterial effect on our ARPU for 2012. In the fourth quarter of 2013 we removed approximately 64,000 subscribers from our subscribers base, following a change to our prepaid subscribers counting mechanism. As a result of such change, we add a prepaid subscriber to our subscribers base only upon charging a prepaid card and remove them from our subscribers base after six months of no revenue generating calls or SMS. Following each of these changes, we have not restated prior subscriber data to conform to such changes.

 

Business Strategy

 

Our goal is to strengthen our position as a leading Israeli telecommunications group. The principal elements of our business strategy are as follows:

 

·Offering our customers comprehensive telecommunications solutions. We offer our customers a wide range of cellular and landline telecommunications services. We focus our offerings on bundles of services, which as of May 2015 also included triple play bundles of internet infrastructure (through the landline wholesale market using Bezeq's VDSL infrastructure) and ISP, landline telephony and TV services), as they enhance customer loyalty to us. We also offer a one stop shop for the group's portfolio of services, in both customer service and sales. In addition, we intend to continue to leverage our leading position and large market share in those businesses for cross-sales and the offering of new services which are found to be synergistic to those businesses, such as our OTT TV services and internet infrastructure services, in order to increase our overall revenues and market share.

 

·Growing in wireline services. We intend to continue to expand our landline business with both private and business customers. For private customers, we provide Internet infrastructure (via Bezeq's infrastructure through the wholesale market) and ISP, home telephony services (VOB, via Bezeq's and Hot's infrastructure), OTT TV services as well as ILD services. For business customers, we provide a wide range of telecommunications services, including Internet infrastructure (via Bezeq's VDSL infrastructure through the wholesale landline) and ISP, transmission services, ILD, landline telephony services, as well as hosting and data security services. These, combined with approximately 1,780 kilometer inland fiber-optic network, our microwave infrastructure, and Netvision's high penetration in business parks and industrial centers, provide us with the ability to selectively offer cost-efficient landline telecommunications solutions to business customers and integrated offerings of landline and cellular services.

 

·Optimization of cost structure. We continue our efforts to reduce costs and improve our efficiency. In 2015, we continued taking other aggressive efficiency measures, through adjustments to the existing head count, a reduction in overhead expenses and improvement of work processes. We plan to continue streamlining our costs in 2016, including organizational and personnel changes, and also through our agreement to purchase Golan, if approved and executed.

 

Agreement for the Purchase of Golan

 

In November 2015, we entered an agreement with Golan and its shareholders for the purchase of 100% of the shares of Golan, for the sum of NIS 1.17 billion, or Purchase

 

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Agreement and Purchase Price, respectively. The Purchase Price is subject to certain adjustments, including due to specified material adverse events with respect to Golan.

 

Golan is one of the four other MNOs operating in Israel in addition to us. It launched operations in 2012 with a strong brand recognized for low-cost services, and primarily provides cellular services to approximately 900,000 customers (as of November 2015), with a comparatively low churn. For the year ended December 31, 2014 and the six months ended June 30, 2015, Golan's revenues were NIS 395 million and NIS 243 respectively, and net profit was NIS 21 million and NIS 2 million, respectively (according to information provided by Golan to us).

 

If approved by the regulators and consummated, we expect our purchase of Golan to, among other benefits, increase our cellular subscriber market share and our revenues, provide us with opportunities to offer our other services and products to Golan's subscribers and provide opportunities for cost synergies.

 

The purchase of Golan is another step in turning us into a leading telecommunication group that provides high value at low prices to the Israeli consumer. We intend to operate Golan Telecom as an independent company.

 

The main provisions of the Purchase Agreement include:

 

·Up to NIS 400 million out of the Purchase Price shall be paid in the form of a mandatorily convertible 5 year note issued to the sellers by us. The note shall be repaid through the issuance of our ordinary shares. The sellers may request conversion or assign the note at any time after the second anniversary of the closing date, at which time, we may elect, at our sole discretion, to repay the sellers by the equivalent market value of the shares, rather than issue the shares. Golan's shareholders will receive limited customary registration rights in relation to such shares.

 

·Golan shall continue to purchase national roaming services from us, until the earlier of the closing date or a certain date specified in the Agreement following its termination date and as of January 2016, shall increase its monthly payment to us to approximately NIS 21 million, or Monthly Consideration. After closing, we shall no longer receive national roaming revenues. The parties further agreed to postpone the payment date for the difference between the sum Golan has been paying us and the sum it is obligated to pay us under the national roaming services agreement, which was set to NIS 600 million, until the earlier of the valid termination of the Purchase Agreement or the lapse of 12 months from the signing of the Purchase Agreement, if no closing is reached by then. The network sharing agreements between us and Golan are void.

 

·The Purchase Agreement contains generally customary representations, covenants, indemnification arrangements, closing conditions and termination terms. Specific closing conditions include the receipt of the approvals of the Israeli Ministry of Communications and the Antitrust Commissioner, and absence of a material adverse change in Golan's condition, as defined in the Purchase Agreement. The Purchase Agreement can be terminated by either party if closing does not occur until the lapse of 12 months from the Purchase Agreement date.

 

We intend to finance the Purchase Price through a combination of equity and debt. We expect that in addition to the said NIS 400 million convertible note, we would issue approximately NIS 200 million of equity (which may include a rights offering) and will finance the remainder from internal sources and a debt raising.

 

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There is no assurance that the Agreement shall be approved by the Israeli regulators, which we expect will be challenging, specifically in light of the opposition to the transaction, led by the Ministry of Treasury, nor as to the execution of such a sale.

 

For risks related to the purchase of Golan, see "Item 3. Key Information – D. Risk Factors – Risks Related to the Proposed Acquisition of Golan Telecom Ltd." above.

 

Cellular Services and Products

 

As of December 31, 2015, we provided cellular communications services to approximately 2.845 million subscribers, including basic cellular telephony services, text and multimedia messaging, data and other value-added services as well as handset sales. Not all services are supported by all handsets or by all of our networks.

 

We offer our cellular subscribers a variety of usage and sector pricing plans and bundles combining cellular services with other communications services that our group offers, such as Internet infrastructure and ISP, landline, ILD and OTT TV services for home and IP switchboard, Internet infrastructure and ISP landline and ILD services for the office. We offer two methods of payment: pre-paid and post-paid. Pre-paid services are offered to subscribers who pay for our services prior to obtaining them, usually by purchasing our "Talkman" pre-paid cards or "virtual" Talkman cards. Post-paid services are offered to subscribers who are willing to pay for our services through banking and credit arrangements, such as credit cards and direct debits. Price erosion and the marketing of unlimited packages, have resulted in a constant decline in our pre-paid subscriber base. In line with regulation, our pricing plans do not include a commitment to purchase our services for a predefined period, other than in large business agreements.

 

Basic cellular services

 

Our principal cellular service is basic cellular telephony and data transfer, upload and download (in supporting handsets). Both are included in our "unlimited packages". In addition, we offer many other services with enhancements and additional features to our basic cellular telephony service, including voice mail, cellular fax, call waiting, call forwarding, caller identification and conference calling.

 

Data services can be used with handsets (in supporting models), cellular modems, laptops and tablets. We provide our customers with a variety of "internet surfing packages" for that purpose.

 

We also offer both an outbound roaming service to our subscribers when traveling outside of Israel and an inbound roaming service to visitors to Israel who can "roam" into our network. As of December 31, 2015, we had commercial roaming relationships with 546 operators in 181 countries based on the standard agreements of the GSM organization (an umbrella organization in which all the cellular operators operating with GSM technology are members). In addition, as of December 31, 2015, we had 3G roaming arrangements with 347 of these operators, in 114 countries, (some of them for 4G as well) enabling our 3G and 4G roamers to use data services in the respective countries and visiting roamers in Israel of these operators, to use our 3G and 4G services, respectively.

 

Value-added services

 

In addition to basic cellular telephony and data services, we offer many value-added services, such as SMS and MMS, cloud backup content services such as music downloads

 

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and "Cellcom TV" application. SMS is included in our "unlimited packages". We offer those services that we believe are likely to be popular with subscribers and benefit our business. Some of the value-added services that we offer are available only to subscribers who have supporting handset models and some are offered only to business subscribers.

 

To our business subscribers we also offer multi SMS, M2M, "Double Net" services allowing combined usage of cellular and landline networks in order to insure continuous service, work force management and vehicles management applications.

 

Handsets

 

We sell a wide selection of handsets (which for purposes of this report may include other types of communicationsend-user equipment, such as tablets) designed to meet individual preferences. Prices of handsets vary based on handset features and special promotions. We offer a variety of installment plans for handsets and discounts for short term installment plans, however in most cases, handsets are to be paid in 36 monthly installments. We offer a variety of handsets from world-leading brands such as Apple, LG, Nokia, Samsung, Sony, HTC, ZTE and Alcatel. The vast majority of our handset sales in 2015 have been by Apple and Samsung. The handset models we sell offer Hebrew language displays in addition to English, Arabic and Russian (in most of the models). We are also required to provide cellular services to subscribers who did not purchase their handsets from us, provided that the handset model complies with the standards set by the Ministry of Communications. We offer our subscribers repair services for most handsets, in approximately 28 locations, including through our wholly owned dealer, as well as by dispatch service. See also "Customer Care" below.

 

We also sell modems, tablets and smart watches to promote our data services. In addition, we sell added value products to our customers, such as smart watches.

 

Samsung International Co. Ltd. provides us Samsung products and spare parts for such products, under terms, including price of products, agreed between us and Samsung from time to time.

 

In 2013, we entered into an agreement with Apple Sales International for the purchase and distribution of iPhone products, respectively, in Israel. Under the terms of the agreement, we have committed to purchase a minimum quantity of  iPhone products, respectively, over a period of three years, which have represented a significant portion of our total cellular handsets purchase amounts, respectively, over that period.

 

Landline services

 

In addition to our cellular services, we provide landline telephony, transmission and data services, using our approximately 1,780 kilometers of inland fiber-optic infrastructure and complementary microwave links. We have offered transmission and data services since 2001, landline telephone service since July 2006, and advanced, voice and data landline services since 2008, both to selected business customers. Since May 2015 we (and Netvision) have offered internet infrastructure services through the landline wholesale market, using Bezeq's VDSL infrastructure. Netvision also offers landline services to both private and business customers, focusing on the private sector. For further details, please see "-Netvision" below. For additional details regarding the landline wholesale market and the possible effects

 

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of the provision of broadband infrastructure services by IBC on our landline business, see "Item 4. Information on the Company –Competition - Wireline".

 

As of December 2014, we are also offering OTT-TV services, branded 'Cellcom tv' to private customers and using Netvision's systems. Cellcom tv is an hybrid OTT-DTT TV service provided to the Israeli market. The service includes a set-top box that enables linear channels, including based on the Israeli Digital terrestrial television (DTT) broadcasting, Video on Demand library subscription (SVoD) that can be also accessed by smartphones and tablets (TV anywhere), access to internet video content from selected internet sites, music streaming service and additional advanced features such as personal video recorder, VoD playlist channels and connection to social networks, for a highly competitive price. Our VoD catalogue and linear channels offer international and local content from top content suppliers.

 

In 2012, Netvision entered an agreement with ADB, for the purchase and distribution of set-top boxes and ancillary products and services for our OTT TV services. In June 2015, Cellcom entered an agreement with Altech, for the same purpose.

 

In 2013, Netvision entered an agreement with VU, a leading international supplier of multiplatform video services and solutions, for the supply of international video content and content operation and management services. Under its agreement with VU, Netvision has committed to pay minimum amounts for such content and services. The Agreement is valid until the end of 2018, and may be terminated by Netvision at the end of 2017, subject to certain conditions; and thereafter is renewable for additional periods of one year each, unless terminated by either party, subject to prior notice.

 

Network and Technology

 

General

 

Our cellular network has developed over the years since we commenced our operations in 1994, and we now have dual cellular and wireline capabilities.

 

Our "fourth generation" LTE, or Long Term Evolution technology, was launched in August 2014, offers data throughput of up to 112 Mbps on the downlink path and up to 37 Mbps on the uplink path (voice services are provided through our 3G network). Our LTE network is covering most of the population of Israel and in 2016 we intend to continue the deployment of this network and allocate additional spectrum in the 1800 band (where possible) in order to enable higher data throughput rate.

 

Our "third generation" UMTS/HSPA+, or high-speed packet data access, technology, offers full interactive multimedia capabilities with current data rates of up to 42 Mbps on the downlink path and up to 5 Mbps on the uplink path. In 2016, we intend to continue to support the increasing demand for data traffic, while maintaining its quality of services. This network, considered to be a "3.9" technology, uses the same core as our GSM/GPRS/EDGE network and covers substantially all of the populated territory in Israel. Moreover, our UMTS/HSPA+ network supports types of services that require higher throughput and lower delay, such as video conferencing and provides an adequate fallback for our LTE network by means of smart features and network load sharing.

 

Our "second generation" GSM/GPRS/EDGE 1800MHz network allows for voice calls, data transmission and multimedia services, although at slower speeds than our LTE and

 

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UMTS/HSPA+ networks. Our GSM/GPRS/EDGE technology is an advanced second-generation technology and considered to be a "2.75G" technology. It enables us to deliver multimedia and services at speed rates that are higher than the rates offered through regular "second generation" digital cellular technology. Packet data rates vary from 50 Kbps to 200 Kbps, depending mainly on handset capabilities. In addition, in the case of coverage gaps and for voice services supported by our GSM/GPRS/EDGE technology, the network provides an adequate voice fallback for our LTE and UMTS networks. Most of our traffic uses the UMTS/HSPA+ network with a continuous growth of data using our LTE network.

 

Our transmission network is comprised of approximately 1,780 kilometers of inland advanced fiber-optic cables that, together with our microwave infrastructure, enable us to provide our customers with telephony and high speed and high quality transmission and data services. Our transmission network is strategically deployed in order to cover the major portion of Israel’s business parks and permits us to provide our own backhaul services while reducing our need to lease capacity from Bezeq, the incumbent landline operator in Israel.

 

Our system for the provision of advanced centrex services based on cloud solutions to our business landline customers, is by Broadsoft Ltd.

 

Netvision's platform by LM Ericsson, allows the provision of our OTT TV services, together with the Israeli DTT infrastructure.

 

Cell sites sharing agreement

 

In September 2014, we entered into a co-operation agreement regarding maintenance services for passive elements of cell sites with Pelephone, including unifying passive elements and streamlining costs, through a common contractor. The contractor to be selected by an RFP process, will enter a separate agreement with each of us and Pelephone, generally for a period of at least 5 years. In July 2015, the Israeli Antitrust Commissioner approved the co-operation agreement for a period of ten years under certain conditions. However, we have been unable to progress its execution and can provide no assurance that such co-operation will occur in the future.

 

Infrastructure

 

We have built an extensive, durable and advanced cellular network system, enabling us to offer high-quality services to substantially the entire Israeli populated territory. We seek to satisfy quality standards that are important to our subscribers, such as high voice quality, high data rate packet sessions, low "blocked call" rate (average rate of call attempts that fail due to insufficient network resources), low "dropped call" rate (average rate of calls that are terminated not in the ordinary course) and deep indoor coverage. Therefore, we have made substantial capital expenditures and expect to continue to make substantial capital expenditures on our network system.

 

Our LTE network is covering most of the population of Israel and we cover substantially all of the populated areas of Israel with both our UMTS/HSPA+ network and our GSM/GPRS/EDGE network. Our LTE and UMTS/HSPA+ networks are mostly co-located with our GSM/GPRS/EDGE network. The supplier of our LTE network is NSN. The suppliers of our UMTS/HSPA+ network are Ericsson Israel (for part of our 3G radio access network) and NSN (for our core network and part of our radio access network). The supplier

 

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of our GSM/GPRS/EDGE network is NSN. Ericsson and NSN, each with respect to the network supplied by it to us, provide us with maintenance services.

 

In recent years, we have enhanced and expanded both our UMTS/HSPA+ network and our GSM/GPRS/EDGE network, primarily in urban areas, by adding infrastructure to improve outdoor and indoor coverage, including through UMTS/HSPA 850 MHz sites deployed through substantially all of the populated areas of Israel. In 2016, we intend to continue to expand our LTE network coverage.

 

We launched our SDH transmission network in 1999. It is based on Alcatel Lucent and ECI Telecom technology and covers substantially all of the populated areas in Israel, and is maintained by Alcatel Lucent and ECI Telecom. We launched our Carrier Ethernet network in 2010, based on Alcatel Lucent technology. It covers substantially all of the populated areas in Israel and is maintained by Alcatel Lucent. In 2015, we launched an MBH network, by Cisco, intended to support all our cellular traffic. In 2016, we intend to migrate the majority of our cellular sites to this new network.

 

Pursuant to the requirements of our license (as well as the licenses of the other telephony service providers in Israel), our cellular network is interconnected, either directly or indirectly, to the networks of all other telephony service providers in Israel. Our network monitoring system provides around-the-clock surveillance of our entire network. The network operations center is equipped with sophisticated systems that constantly monitor the status of all switches and cell sites, identify failures and dispatch technicians to resolve problems. Operations support systems are utilized to monitor system quality and identify devices that fail to meet performance thresholds. These same platforms generate statistics on system performance such as dropped calls, blocked calls and handoff failures. Our network operations center is located in our Netanya headquarters. In addition, we have duplicate back up center in Ramle, located approximately 30 kilometers, respectively, south of Netanya and a disaster recovery plan, or DRP, for all our engineering systems. We adopted a business continuity plan and a disaster recovery plan to ensure our ability to continue our operation in emergency situations in accordance with a recent amendment to our license.

 

In 2011, Netvision entered an agreement with LM Ericsson, for the purchase of our OTT TV services system and ancillary products and services. Netvision has an option to purchase maintenance services on an annual basis until 2018. Our OTT TV service also uses the Israeli DTT infrastructure. The DTT infrastructure may be used freely by our customers.

 

Cellular Network design

 

We have designed our GSM/GPRS/EDGE, UMTS/HSPA+ and LTE networks in order to provide high quality and reliability in-line with the requirements set forth in our license while using a cost-effective design, utilizing shared components for our networks, where applicable.

 

We have a DRP for our engineering systems, aimed at increasing our network's survivability in case of damage to any of its elements. The DRP also provides our network with additional advantages, including increased capacity and advanced qualities in line with our license requirements.

 

Our primary objective going forward is to continue deploying our LTE network while allocating a smaller amount of our 1800MGz frequencies to our 2G network, where possible,

 

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through advanced and modern equipment and software features, and to continue to support the increasing demand for data traffic of our high speed UMTS/HSPA+ network. At the same time we intend to continue to perform extensive optimization work to provide our subscribers with maximum capability to support video and other broad-bandwidth content. See "Item 3. Risk Factors – We may be adversely affected by significant technological and other changes in the cellular communications industry ".

 

Cellular Network performance

 

We continually optimize our entire network in order to meet the key performance indicators for our services, including dropped calls, voice quality, accessibility, availability and packet success rate. We use advanced planning, monitoring and analyzing tools and introduce advanced and modern equipment and software features in order to achieve our performance goals efficiently and with minimum faults.

 

The main indicators that we use to measure network performance for voice and packet data are the "blocked call" rate, the "dropped call" rate and average throughput. Our average rates of blocked and dropped calls meet those required by our license. The average throughput indicator is not set in our license.

 

Spectrum allocation

 

Spectrum availability in Israel is limited and is allocated by the Ministry of Communications through a licensing process. We have been allocated 2x10 MHz in the 850 MHz frequency band previously used by our TDMA network and currently by our UMTS/HSPA base stations, 2x20 MHz in the 1800 MHz frequency band, 5 - 15 MHz (varying dependent on usage required in different areas) of which are used by our LTE network and the remaining is used by our GSM/GPRS/EDGE network (again varying dependent on usage required in different areas) and 2 x 10 MHz 2100 MHz frequency band used by our UMTS/HSPA network. We believe that our available spectrum is sufficient for our current needs.

 

Out of the 20 1800 MHz, 3MHz were allocated to us in August 2015 by the Israeli Ministry of Communications, for 4G technologies (such as LTE, LTE Advanced) . Unlike our other frequencies, allocated to us for the duration of our license, these frequencies were awarded to us for a period of 10 years only.

 

Cell site construction and licensing

 

We construct cell sites based on our strategy to expand the geographical coverage and improve the quality of our network and as necessary to replace cell sites that need to be removed. Our acquisition teams survey the area in order to identify the optimal location for the construction of a cell site. In urban areas, this would normally be building rooftops. In rural areas, masts are usually constructed. Our transmission teams also identify the best means of connecting the base station to our network, based on our independent transmission network, either by physical optical fiber, microwave link or Bezeq landlines. Once a preferred site has been identified and the exact equipment configuration for that site decided, we begin the process of obtaining all necessary consents and permits. The construction of cell sites requires building permits from local or regional authorities, or an applicable exemption, as well as a number of additional permits from governmental and regulatory authorities, such as construction and operating permits from the Ministry of Environmental Protection in all cases, permits from the Civil Aviation Authority in most cases and permits from the Israeli

 

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Defense Forces in some cases. In special circumstances, additional licenses are required. See "Item 4. Information on the Company – B. Business Overview – Government Regulations—Permits for Cell Site Construction."

 

Suppliers

 

In April 2014 we entered a framework agreement with NSN Israel, of Nokia Solutions and Networks group, a worldwide leading network manufacturer, for the purchase of an LTE network, which also supports LTE Advanced technology (4.5 generation) and related services. This agreement will also govern the purchase and services provided under our previous agreement with NSN, in relation to our GSM/GPRS and EDGE networks, UMTS core system and a UMTS/HSPA radio access network and related products and services. We have an option to purchase maintenance services on an annual basis until March 2030.

 

We entered into an agreement with LM Ericsson in September 2005 for the purchase of UMTS radio access network and ancillary products and services and in December 2011 for the purchase of upgraded UMTS /HSPA products and related services. We have an option to purchase additional maintenance services on an annual basis until 2026.

 

We use Telcordia’s (which was acquired by Ericsson) intelligent platform, or "IN," to provide services to our GSM/GPRS/EDGE, UMTS and LTE networks, allowing us, at minimal cost, to internally develop sophisticated services with a short time-to-market that are customized to local market requirements. Our IN platform supports all relevant IN protocols, which allows us to provide (subject to applicable roaming agreements) advanced roaming services, including Virtual Home Environment, abbreviated dialing, unified access to voice mail, VPN, local number format from subscribers’ phone book and call screening.

 

In addition, we have agreements with several Israeli engineering companies for the construction of our cell sites. We also purchase certain network components from other suppliers.

 

Transmission network

 

Our transmission network provides us with wireline connectivity for our cellular and landline network in substantially all of the populated territory of Israel. It is based on our fiber-optic network and complementary microwave infrastructure. Our transmission network includes links to our internal cellular network and to our landline and transmission subscribers.

 

Our optical transmission network is deployed from Nahariya in the north to Beer Sheva in the south and Afula and Jerusalem in the east, consisting of approximately 1,780 kilometers. The fiber-optic network reaches most of the business parks in the country and is monitored by a fault-management system that performs real-time monitoring in order to enable us to provide our subscribers with high quality service. In order to efficiently complete our transmission network’s coverage to substantially the entire country, we use a microwave network as a complementary solution in those areas that are not served by our fiber-optic network. As of December 31, 2015, we had approximately 2,718 microwave links to both our cell sites and subscribers.

 

In 2015 we continued to expand our Carrier Ethernet network and our ISP network backbone in Israel and abroad in order to support growing demand for capacity, upgraded the capabilities and capacity of our customer Quality of Experience systems and upgraded and

 

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improved the capabilities of our central system for the protection of our network against cyber attacks.

 

Under our agreement with Alcatel Lucent, we purchased an SDH transmission network. We purchase maintenance services for the network on an annual basis.

 

In November 2009, we entered into an agreement with Alcatel Lucent for the purchase of our Carrier Ethernet network. We also agreed to purchase from Alcatel Lucent at least 51% of the equipment and services that we purchase for such network until the lapse of 7 years from final acceptance (until February 2017). We have an option to purchase maintenance services until 2022.

 

In February 2015 we entered an agreement with Bynat Communications Computers Ltd., or Bynat, for the purchase and maintenance of an MBH transmission network by Cisco. In the agreement we agreed to purchase maintenance services for a term of 5 years from final acceptance (until 2019), and we may stop purchasing such services subject to a termination fee. Thereafter we have an option to purchase maintenance services for a term of 8 years (until 2027).

 

To supplement our transmission network, we lease a limited amount of transmission capacity from Bezeq, the incumbent landline operator. Netvision owns a small transmission network and leases most of the transmission capacity it requires from us, Bezeq, Hot and Partner.

 

Information technology

 

We maintain a variety of information systems that enable us to deliver superior customer service while enhancing our internal processes.

 

In 2010 - 2015, we entered into several agreements with Amdocs (Israel) Limited, or Amdocs, for the provision of operation, maintenance, management and development services for our and Netvision's billing and customer care systems as well as for the development of a new version for our billing system, to serve Netvision as well as an agreement to replace our and Netvision's current CRM systems and serve both companies. In February 2016, those agreements were consensually terminated by mutual agreement and our billing and CRM systems are supported mostly internally, including by personnel previously engaged by Amdocs.

 

Netvision currently uses a billing system supported mostly internally and by Intec and a customer care system provided by PeopleSoft and supported mostly internally as well.

 

We use Nortel’s CTI system for the management of incoming calls to our telephonic call centers.

 

Our current customer care system presents our customer care employees with a display of a subscriber’s profile based on various usage patterns. This enables us to provide a service based upon information for that particular subscriber.

 

We also use a knowledge management system relating to our various services and products by Aman, branded "Cellcopedia".

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We (and Netvision as of July 2013) use ERP solutions provided by SAP, supported by Rimini Street Inc, or Rimini. We use a data warehouse based on an Oracle data base system and various data mining tools, ETL by Informatica and reports generated by Cognos. The data warehouse contains data on our subscribers’ usage and allows for various analytical segmentation of the data.

 

Cisco provides us and Netvision with maintenance proactive malfunction detection and consultant services for both our IP networks equipment. The agreement is effective until the end of 2019.

 

Sales and Marketing

 

Sales

 

As part of our strategy to fully penetrate every part of the Israeli market, we try to make the purchase of our services as easy and as accessible as possible, while making our sales lineup more cost efficient. Our efforts to adjust our sales operations to meet current market conditions include closing and uniting points of sale and eliminating duplicate points of sale or transferring to more cost effective channels. We offer pricing plans, value-added services, handsets, accessories and related services through a broad network of direct and indirect sales personnel. We design pricing plans and promotional campaigns aimed at attracting new subscribers and enhancing our ability to retain our existing subscribers. We pay our independent dealers commissions on sales, while our direct, employee sales personnel receive base salaries plus performance-based incentives. All of our, and our dealers', sales and other customer-facing staff go through extensive training prior to commencing their work. Our distribution and sales efforts for subscribers are conducted primarily through four channels:

 

Points of sale. We distribute our products and services through a broad network of physical points of sale providing us with nationwide coverage of our existing and potential subscriber base.

 

We operate directly, using our sales force and service personnel, at approximately 28 physical points of sale and service (having closed two points of sale and service in 2015), located in central and other frequently visited locations to provide our subscribers with easy and convenient access to our products and services. In 2015, we reduced the space of several additional points of sale, and we may continue to do so in 2016.

 

We also distribute our products and services indirectly through a chain of dozens of dealers (including our own wholly owned dealer, Dynamica) who operate at approximately 150 points of sale throughout Israel. Our dealers are compensated for each sale based on qualitative and quantitative measures. We closely monitor the quality of service provided to our subscribers by our dealers. In our efforts to penetrate certain sectors of our potential subscriber base, we select dealers with proven expertise in marketing to such sectors.

 

Telephonic sales. Telephonic sales efforts target existing and potential subscribers who are interested in buying or upgrading handsets and services. Our sales representatives (both in-house and outsourced) offer our customers a variety of products and services, both in proactive and reactive interactions.

 

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Account managers. Our direct sales force for our business customers maintains regular contact with our mid-sized and large accounts, focusing on sales of cellular and wireline services, customer retention and tailor-made solutions for the specific needs of such customers. We provide small and mid-sized business customers one focal point to both sales and services by phone. Our account managers are aided by our various back office experts in determining customers' needs and making suitable offers. Sales to larger business customers or governmental and local authorities sometimes involve participation in the customer's tender process.

 

Online sales. We offer our customers the ability to purchase our products and services through our internet site and our smartphone application and invest efforts in directing our customers toward self-service channels. We have established a dedicated internet site for the marketing and sales our OTT TV service.

 

Marketing

 

Our marketing strategy emphasizes our position as a market leader, our value for money and our provision of a comprehensive solution for our customers' communication needs, by offering services bundles, which combine a package of voice and SMS usage, cellular data, ISP, landline and ILD services for families and following commencement of our OTT TV and internet infrastructure services, a package of voice and SMS usage, cellular data, ILD services and OTT TV service and triple play bundle of OTT TV, internet infrastructure and ISP and landline telephony services and bundles offerings which combine a package of voice and SMS usage, cellular data, repair services, IP switchboard, internet infrastructure and ISP service, landline and ILD services for the office for small and mid-sized businesses. We believe the provision of bundles and triple play packages of our services strengthen loyalty and increase customer satisfaction. We aim to provide our customers with a comprehensive quality experience through the various means of communications that they use, including their mobile handset, tablet and laptop. Alongside our focus on packages for a fixed sum, we have substantially reduced the number of calling plans available to our customers, thus reducing our back office operation.

 

From surveys that we conduct from time to time, we learn that subscribers base their choice of communications provider primarily on the following parameters: the services included in the bundle; perceived price of services and handsets; level of customer service; perceived quality of the network; general brand perception; and with regards to the cellular provider - selection of handsets and their compatibility with their needs. Our marketing activities take into consideration these parameters and we invest efforts to preserve our subscriber base and attract new subscribers.

 

We leverage our extensive interactions with our customers to provide the requested services and also to cross- and up-sell cellular and wireline products and services according to customer needs, usage trends and profitability, mostly by using advanced CRM models, to increase customer satisfaction, loyalty and revenues.

 

We regularly advertise in all forms of media, including in promotional campaigns. We also use "one to one" promotional campaigns such as advertisements in our subscribers' monthly bill and in incoming IVR. We believe our marketing and branding campaigns, including our "Cellcom tv" advertisement campaign conducted since the launch of such services, has been very successful and acclaimed among the Israeli public and even contributed to the strength of the "Cellcom" brand. We believe that the success and public

 

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response that the campaigns have generated is the result of the relevance of their messages to our customers, indicating the success of our focus and differentiation from our competitors.

 

Cellcom was ranked by Globes as the leading and strongest brand of Israel’s cellular market in 2015 for the fifth year in a row, and 'Cellcom tv' was chosen as the 2015 winning launch, both by Israel's marketing association and in a poll taken among Israel's leading marketing VPs. We believe that our strong brand recognition gives us the high level of market exposure required to help us achieve our business objectives.

 

Customer Care

 

Our customer service unit is our main channel for preserving the long-term relationship with our subscribers. We focus on customer retention through the provision of quality service and customer care. In order to achieve this goal, we systematically monitor and analyze our subscribers’ preferences, characteristics and trends by developing and analyzing sophisticated databases. In addition, subscribers are encouraged to subscribe to additional value-added services, mobile data and content services as well other communications services such as internet infrastructure and ISP services, landline telephony and ILD services and our private customers – OTT TV services as well, in order to enhance customer satisfaction and increase ARPU, with a specific focus on bundles of services. We invest large resources in the quality of our service to our customers. Our customer care representatives receive extensive training before they begin providing service and thereafter regularly undergo training and review of their performance. We provide our customer care representatives with a continually updated database, thus shortening the interaction time required to satisfy the customer’s needs and preventing human errors and closely monitor the service provided by them, in order to assure its quality. We constantly review our performance by reviewing customers applications and conducting surveys among our subscribers in order to ensure their satisfaction with our services and to improve them as necessary. In addition, we constantly apply preventive and preemptive measures aimed at reducing churn.

 

In our efforts to adjust our costs to new market conditions, we have closed or unified walk-in centers in neighboring locations and reduced or relocated call centers, operating them in a more cost effective fashion, while placing greater focus on self-service channels and proactive malfunction resolution, identifying and solving problems ahead of customer complaint.

 

In order to respond to subscribers’ needs in the most efficient manner, our customer support and service operation offers several channels for our subscribers:

 

Call centers. In order to provide quick and efficient responses to the different needs of our various subscribers, our call-center services are divided into several sub-centers: general services; technical services; billing; sales; international roaming; and data and internet. We are constantly reviewing the effectiveness of our service and in 2014, we commenced operating a multi-function call center providing all our services. The call center services are provided in four languages: Hebrew, Arabic, English and Russian. We regularly monitor the performance of our call centers. We currently operate call centers in nine locations throughout Israel, four of which are outsourced. In 2015, we witnessed an additional decrease in calls to our calls centers. During peak hours our call centers have the capability to respond to 600 customer calls

 

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simultaneously. We are making efforts to reduce the number of calls to our call centers by offering simple price plans and promoting our self-service channels.

 

Walk-in centers. As of December 31, 2015, we independently operated approximately 28 service and sales centers, having closed two more points of sale and service in 2015, with approximately 150 additional sale and service points operated by our dealers (including our wholly owned dealer, Dynamica), covering almost all the populated areas of Israel. These centers provide a walk-in contact channel and offer the entire spectrum of products and services that we provide to our subscribers and potential subscribers (the majority of which are provided in our dealers' sale and service points as well), including handset sales, accessories sales (by our wholly owned dealer Dynamica), upgrades and other services, such as bill payment, pricing plan changes and subscriptions to new services. These stores are mostly located in central locations, such as popular shopping malls. The majority of our walk-in centers offer handset repair service for the more minor malfunctions whereas for the more major malfunctions and where on-site repair service is not available, our walk-in centers serve as a contact point in which our subscribers deposit their handsets for repair and receive the repaired handset after two business days in the same center or at a location of their choice by a courier, with the repair services conducted in a central lab.

 

Self-services. We provide our subscribers and potential subscribers with various self-service channels, such as interactive voice response, or IVR, internet site and our smartphone application, automatic and live chat and live sms chat, and mobile phone application, where they can receive general and specific information, including pricing plans, account balance, information regarding our various services and products and trouble shooting and handset-operation. We invest efforts in directing our customers to use self-service channels.

 

Our business sales force and back office personnel also provide customer care to our business customers. We provide small and mid-sized business customers one focal point to both sales and services by phone. We offer our business customers repair services by a dispatch service collecting the handset within 48 hours and returning the repaired handset within 48 hours, during which time, the customer is provided with a substitute handset, free of charge.

 

Customer service for our OTT TV and landline wholesale market services and Netvision services is provided in our independently operated service centers and through technicians providing services at the customers' homes.

 

All of our service channels are monitored and analyzed regularly in order to assure the quality of our services and to identify areas where we can improve.

 

We constantly invest time and efforts making our services compatible to persons with disabilities. We provide customers with disabilities convenient accessibility to our premises and adapted products and services, including sign language customer care at our walk-in services, free dispatch services, and the option to receive sales in the customer's home. We work closely with Accessibility Israel, a leading Israeli non-profit organization advancing accessibility for persons with disabilities in Israel, and train our representatives to provide accessible service to all our customers.

 

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We entered into an agreement with Be’eri Printers for our printing supplies and invoices as well as the distribution, packaging and delivery of invoices and other mail to the postal service distribution centers in 2003. The agreement is valid until June 2017 and either party may terminate it previously, by advanced written notice to the other party.

 

Competition

 

Communications groups and structural separation

 

The Israeli telecommunications market is currently dominated by four communications groups: Bezeq, Hot, Partner-012 Smile and Cellcom–Netvision. Each of the Bezeq and Hot groups are subject to certain structural separation requirements in relation to sale of bundles of services by Hot and Bezeq and their respective subsidiaries, as a result of being the incumbent and monopoly in their respective core business – landline and multichannel television services. In addition to certain relaxation of the structural separation imposed on the Bezeq group as of 2010, allowing it to offer bundles of services with its subsidiaries, in2015, Bezeq merged with Yes, Bezeq's subsidiary providing multichannel pay-TV, under certain conditions (detailed under "-Wireline" below). Although the Hot group is also subject to structural separation limitations between its multi-channel television, ISP, cellular and landline services, it was allowed to offer a bundle of landline telephony, multichannel television and internet infrastructure services and under certain conditions ISP services as well, and as of 2011, Hot and Hot Mobile are also allowed to sell and market each other's services and exchange information. Bundle offerings have accelerated and are expected to accelerate competition and price erosion in each of the services included, especially in those services which are not the core services of the Bezeq and Hot groups. For possible annulment of the structural limitations following the execution of a wholesale market of landline services or future investment in wireline infrastructure or a proposed change to the ILD services regulation, or approval of mergers in the Bezeq and Hot groups, see "- Wireline" below, "-Government Regulations – Landline" and "Netvision - Internet infrastructure and ISP Business - Competition", "Netvision - Telephony Business - Competition".

 

Cellular

 

There is intense competition in all aspects of the cellular communications market in Israel, which has been intensifying further since 2012, with a penetration rate (the ratio of cellular subscribers to the Israeli population) of approximately 127%, representing approximately 10.5 million cellular subscribers at December 31, 2015, and the average annual churn rate in Israel in 2015 is estimated to be 38%, higher than the churn rates in other developed economies. We expect this intensified competition to continue in the future. We currently compete for market and revenue share with eight other cellular communications operators: four MNOs (Partner, Pelephone, Hot Mobile and Golan (which we agreed to purchase in November 2015, subject to regulatory approvals )) and four MVNOs (Rami Levy Hashikma Communications Marketing Ltd., or Rami Levy, Home Cellular Ltd. (whose purchase by us is pending approval of the Ministry of Communications), or Home Cellular, Azi Communications Ltd., or Azi and Cellact Communications Ltd., or Cellact). Marathon 018 Ltd., or Marathon, is expected to be awarded the 6th MNO license, after winning frequencies in the recent 4G frequencies tender.

 

Our estimated market share based on number of subscribers was approximately 27% as of December 31, 2015. Estimated market shares at such time of Partner, Pelephone, Hot

 

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Mobile and Golan were estimated to be approximately 26%, 25%, 11.6% and 8.5%, respectively and the MVNOs' collective market share was estimated to be 1.6%. These estimates are based on the public reports of other operators and our estimate of the market share of the operators who do not publish reports.

 

Hot Mobile and Golan commenced their UMTS operation in May 2012. Rami Levy, Home Cellular, Azi and Cellact, all mobile virtual network operators, commenced operations in December 2011, April 2012 , July 2013 and December 2013, respectively.

 

Partner started operations in 1998 and is controlled by S.B. Israel Telecom Ltd. (indirectly controlled by the media entrepreneur Haim Saban) and Scailex, an Israeli company listed on the TASE, and by its affiliate Suny, the official importer of Samsung cellular phones to Israel. In March 2011, Partner purchased the outstanding shares of 012 Smile Telecom Ltd., or Smile Telelcom, an ISP and ILD operator, now also serving as Partner's cellular low cost brand dealer and in 2015, its network sharing agreement with Hot Mobile was approved and the two companies began joint operation through a joint subsidiary.

 

Pelephone is a wholly-owned subsidiary of Bezeq, the incumbent landline operator and started operations in 1986. As of January 2015, its low cost brand services are sold by another subsidiary of Bezeq – Walla Communications Ltd., an internet portal. In 2015, Pelephone purchased the operation (including subscribers) of Alon Cellular Ltd., an MVNO operator. Bezeq is controlled by B Communications Ltd., or B Communications,. B Communications is an Israeli company traded on the NASDAQ and the TASE and controlled by Internet Gold Golden Lines Ltd., or Internet Gold. Both B Communications and Internet Gold form part of the Eurocom Communications Group, or Eurocom, controlled by the Israeli businessman Shaul Alovich.

 

Hot Mobile (previously named Mirs Communications Ltd.) had its license upgraded from push-to-talk to a cellular license in February 2001. In mid-2012 it began its UMTS operation. Hot Mobile is owned by Hot Telecom, or Hot, which is owned by the French businessman Mr. Patrick Derhy. The Hot group provides multichannel pay-TV services, Internet infrastructure and ISP services, and landline telephony services. In 2015, its aforementioned network sharing agreement with Partner was approved and the two companies began joint operation through a joint subsidiary.

 

Golan is owned by Xavier Niel, founder and controlling shareholder of the French telecom company Iliad - Free, Patrick and Gerard Pariente, founders and former owners of Naf Naf, a European fashion brand, Michael Golan, the CEO of Golan and former CEO of the French telecom company Iliad – Free and David Golan. Golan began to operate in mid-2012. In November 2015, we entered an agreement with Golan and its shareholders for the purchase of Golan, subject to certain conditions including regulators' approvals, as described under " – Agreement for the Purchase of Golan" above.

 

Rami Levy is a subsidiary of a major Israeli discount supermarket chain. Home Cellular is a subsidiary of a leading 'do it yourself' stores chain. Azi is owned by Telzar, an ILD operator. Cellact is owned by Cellact Ltd., a content provider.

 

The competition in the cellular communications market intensified following the entry of additional cellular operators to the market, specifically the launch of two new UMTS operations by Hot Mobile and Golan in mid 2012, without having to first invest in building their own network, with significantly lower tariffs than market level at that time for private

 

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customers. This has led to a material increase in churn rate and accelerated and continuous price erosion and a material decrease in revenues and profitability for us. Since 2015, Hot Telecom has been targeting the business sector, offering lower tariffs than market level, which led to increased competition and price erosion in that sector as well.

 

Handsets

 

In the handsets market, we compete with numerous vendors, chain stores and importers' stores. Regulatory decisions in recent years alleviating the regulatory requirements on the import to and sale of handsets in Israel, coupled with regulatory decisions preventing cellular operators from linking handsets sale and cellular services, led to the entry of additional competitors into the market, significantly increased competition and decreased sales for us. See "Item 4. Information on The Company - Government Regulations – Tariff Supervision" for additional details. That, coupled with the growing change in the business market where corporations no longer purchase cellular services for their employees from a designated operator but rather allow each employee to purchase his or her own device and obtain cellular services from their operator of choice, known as the "bring your own device" phenomenon, may further increase the competition in this market.

 

Wireline

 

The Israeli landline telephony market has been dominated for many years by Bezeq, the incumbent landline monopoly which held as of March 31, 2015 (according to the Ministry of Communications report) approximately 2/3 of the landline telephony market (and an even larger market share in the business landline telephony sector(. Hot, the incumbent TV monopoly, entered this market in recent years and was allowed to bundle its landline service together with its internet infrastructure and its multi-channel television service. Bezeq and Hot groups are the only groups owning full landline infrastructure in Israel and offering internet infrastructure services to both ISPs and end-users. Other players include us, Netvision, Partner, Smile Telecom and Bezeq International. The landline wholesale market was to allow wholesale landline telephony service as of May 2015. As of the date of this report, no wholesale landline telephony services are provided. In December 2015 the Ministry of Communications published a hearing proposing an interim alternative by which operators without infrastructure would be allowed to resell Bezeq's telephony (for tariffs substantially higher that those set for the wholesale service) and in January 2016, the Ministry of Communications announced it will not interfere with the tariffs Hot proposes for its wholesale telephony service. We believe the resale alternative will not result in competition in this field. For details see "- Government Regulation – Landline".

 

Transmission and landline data services are provided by Bezeq, Hot, Partner and us. These services are provided to business customers and to telecommunications operators.

 

Multichannel pay-TV services are dominated by Hot (the incumbent TV provider and monopoly in this field) and YES, (a subsidiary of Bezeq) with approximately 828,000 and 639,000 households, respectively, as of September 30, 2015. The multichannel pay-TV market is also highly penetrated with levels above those of most developed economies. We successfully entered this market in December 2014, using an hybrid OTT-DTT television service, with approximately 63,000 households subscribed to our Cellcon tv services as of December 31, 2015. DTT broadcasting may be used by additional players as well, to be bundled with additional IPTV or Over the Top (OTT) channels, as we do. Partner, Rami Levy and Golan also announced they are considering entering this market and in January 2016,

 

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Netflix, the American internet based VOD content provider, announced it is opening its services to viewers in additional countries including Israel, though without translation of the content and user interface or local content, and it is expected to provide a complementary service to the existing competitors' content. In March and September 2014, the Israeli Antitrust Commissioner, aiming to facilitate the entry of new competitors to the TV market by reducing entry barriers, published the following requirements as a precondition for the approval of any merger in each of the Bezeq and Hot groups: (1) Bezeq to generally not bill ISPs for TV related internet infrastructure services, annul and not engage in any non-original production exclusivity arrangements; and (2) both Bezeq/ Yes and Hot to allow new TV service providers to purchase certain original production of Bezeq for two years from the approval of the merger. The Bezeq –Yes merger was completed in 2015. For details of the ISP and ILD markets, see "Netvision - Internet infrastructure and ISP Business" and "Netvision - Telephony Business" below.

 

Internet infrastructure services are provided by Bezeq and Hot to approximately 1.27 million and 694,000 households in Israel, respectively, with an immaterial quantity provided by IBC. As of the first half of 2015, internet infrastructure services are provided by other operators, including us, through the landline wholesale market, using Bezeq's VDSL infrastructure. Based on Bezeq and Hot reports, at the end of September 2015, the Internet infrastructure services household penetration rate was approximately 74%. We bundle this service with our ISP service and also as part of our triple play offering. As of December 31, 2015, we had approximately 94,000 households subscribed to our internet infrastructure services. In January 2016, the Ministry of Communications published a hearing proposing maximum tariffs for Hot's wholesale internet structure services. Effective inclusion of Hot's infrastructure in the wholesale market may increase the amount of potential subscribers to our triple play and bundle offerings. For the details regarding a wholesale landline market in Israel see "-Government Regulations – Landline" below.

 

While an effective wholesale landline market, specifically one including both Bezeq and Hot's infrastructure and providing both telephony and infrastructure services, will enhance our ability (including through Netvision) to compete and extend our service offering, the intended annulment or substantial alleviation of structural separation and Bezeq's tariffs supervision, may have a material adverse effect on our competitive capabilities and results of operation, more so if effected before an effective wholesale market is in place. Further, the entry of new competitors to the landline market, through the wholesale market, has and may trigger further escalation in the competition in other markets in which we operate, such as the ISP. The effectiveness of the wholesale landline services and our ability to offer these services is dependent on the manner of implementation of the wholesale services and the cooperation of the infrastructure owners in the execution of the regulator's decisions and in relation to issues and processes not regulated, which, until now, was lacking.

 

For further details see below in this Item 4. B. under "- Netvision".

 

Competition – general

 

The principal competitive factors in the telecommunications market include the services included in the bundle, perceived price, general brand perception and customer service.

 

In response to the enhanced competition in the Israeli telecommunications market, we have implemented various steps and strategies, including:

 

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·identifying new opportunities to maximize our advantages as a communications group, such as our successfully launched television over the internet services and internet infrastructure services through the landline wholesale services;

 

·focusing on the offering of bundles of services, as it strengthen customer retention and on enlarging customer purchases from us;

 

·agreeing to acquire Golan (subject to certain conditions including regulators' approvals), to increase our offering possibilities and sales opportunities to additional customers;

 

·investing in our network to ensure our ability to offer quality and advanced cellular and wireline services, including in our 4G network and providing our customers with the most advanced services; and

 

·taking aggressive efficiency measures through adjustments to our existing head count, reducing overhead expenses and improving work processes, in order to reduce costs and improve our agility.

 

Our ability to compete successfully will depend, in part, on our ability to anticipate and respond to trends and events affecting the industry, including: the introduction of new services and technologies, changes in consumer preferences, demographic trends, economic conditions, pricing strategies of competitors and changes to the legal and regulatory environment.

 

Competition may intensify further as a result of the occurrence of any of the events described under "Item 3. Key Information – D. Risk Factors – Risks Related to our Business – We face intense competition in all aspects of our business."

 

Intellectual Property

 

We are a member of the GSM Association, together with other worldwide operators that use GSM technology. As a member of the association, we are entitled to use its intellectual property rights, including the GSM logo and trademark.

 

We are the proprietor of approximately 30 domain names and approximately 100 trademarks and trademarks applications, the most important of which are the star design, "Cellcom", "Talkman", "Cellcom Volume" and "Cellcom tv". Netvision is the proprietor of approximately 100 domain names and approximately 30 trademarks, the most important of which are "Netvision" and "013 Netvision".  We are also the proprietor of a few registered patents.

 

Government Regulations

 

The following is a description of various regulatory matters that are material to our operations, including certain future legislative initiatives that are in the process of being enacted. There can be no certainty that the future legislation described here will be enacted or that it will not be subject to further change before its final enactment.

 

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General

 

A significant part of our operations is regulated by the Israeli Communications Law, 1982, the regulations promulgated under the Communications Law and the provisions of our licenses, which were granted by the Israeli Ministry of Communications pursuant to the Communications Law. We are required by law to have a license in order to provide certain communications services in Israel. The Ministry of Communications has broad supervisory powers in connection with the operations of license holders and is authorized, among other things, to impose financial penalties for violations of the Communications Law, the regulations and our licenses. For a description of the principal licenses held by Netvision see below in this Item 4.B under the caption "- Netvision".

 

Our principal license

 

The establishment and operation of a cellular communications network requires a license pursuant to the Communications Law for telecommunications operations and services and pursuant to the Israeli Wireless Telegraph Ordinance (New Version), 1972, for the allocation of spectrum and installation and operation of a cellular network.

 

We provide our cellular services under a non-exclusive general license granted to us by the Ministry of Communications in June 1994, which requires us to provide cellular services in the State of Israel to anyone wishing to subscribe. The license expires on January 31, 2022, but may be extended by the Ministry of Communications for successive periods of six years, provided that we have complied with the license and applicable law, have continuously invested in the improvement of our service and network and have demonstrated the ability to continue to do so in the future. The main provisions of the license are as follows:

 

·the license may be modified, cancelled, conditioned or restricted by the Ministry of Communications in certain instances, including: if required to ensure the level of services we provide; if a breach of a material term of the license occurs; if DIC (or a transferee or transferees approved by the Ministry of Communications), in its capacity as our founding shareholder, holds, directly or indirectly, less than 26% of our means of control (with "means of control" defined for these purposes as voting rights, the right to appoint a director or general manager, the right to participate in distributions, or the right to participate in distributions upon liquidation); if our founding shareholders who are Israeli citizens and residents hold, directly or indirectly, less than 20% of our means of control (DIC, as founding shareholder, has undertaken to comply with this condition); if at least 20% of our directors are not appointed by Israeli citizens and residents from among our founding shareholders or if less than a majority of our directors are Israeli citizens and residents; if any of our managers or directors is convicted of a crime of moral turpitude and continues to serve; if we commit an act or omission that adversely affects or limits competition in the cellular communications market; or if we and our 10% or greater shareholders fail to maintain combined shareholders’ equity of at least $200 million;

 

·it is prohibited to acquire (alone or together with relatives or with other parties who collaborate on a regular basis) or transfer our shares, directly or indirectly (including by way of creating a pledge which if foreclosed, will result in the

 

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transfer of shares), in one transaction or a series of transactions, if such acquisition or transfer will result in a holding or transfer of 10% or more of any of our means of control, or to transfer any of our means of control if as a result of such transfer, control over our company will be transferred from one party to another, without the prior approval of the Ministry of Communications. For the purpose of the license, "control" is defined as the direct or indirect ability to direct our operations whether this ability arises from our articles of association, from written or oral agreement or from holding any means of control or otherwise, other than from holding the position of director or officer;

 

·it is prohibited for any of our office holders or anyone holding more than 5% of our means of control, to hold, directly or indirectly, more than 5% of the means of control in Bezeq or another cellular operator in Israel, or, for any of the foregoing to serve as an office holder of one of our competitors, subject to certain exceptions requiring the prior approval of the Ministry of Communications;

 

·we, our office holders and our interested parties, may not be parties to any arrangement whatsoever with Bezeq or another cellular operator that is intended or is likely to restrict or harm competition in the field of cellular services, cellular handsets or other cellular services. For the purpose of the license, an "interested party" is defined as a 5% or greater holder of any means of control;

 

·we are subject to the guidelines of Israel’s General Security Services, which may include requirements that certain office holders and holders of certain other positions be Israeli citizens and residents with security clearance. For example, our Board of Directors is required to appoint a committee to deal with matters concerning state security. Only directors who have the requisite security clearance by Israel’s General Security Services may be members of this committee. In addition, the Minister of Communications is entitled under our license to appoint a state employee with security clearance to act as an observer in all meetings of our Board of Directors and its committees;

 

·prior to operating a network, we are required to have agreements with a manufacturer of cellular network equipment for the duration of its intended operating period, which must include, among other things, a know-how agreement and an agreement guaranteeing the supply of spare parts for our network equipment for a period of at least seven years;

 

·we are required to interconnect our network to other public telecommunications networks in Israel, on equal terms and without discrimination, in order to enable subscribers of all operators to communicate with one another, and are also required to provide national roaming services to new UMTS operators;

 

·we may not give preference in providing infrastructure services to a license holder that is an affiliated company over other license holders, whether in payment for services, conditions or availability of services or in any other

 

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manner, other than in specific circumstances and subject to the approval of the Ministry of Communications;

 

·there are certain general types of payments that we may collect from our subscribers, general mechanisms for setting and raising tariffs, including the basic airtime charging units, and providing cellular services related benefits, reports that we must submit to the Ministry of Communications and an obligation to provide notice to our customers and the Ministry of Communications prior to increasing tariffs and the Ministry of Communications is authorized to intervene in setting tariffs in certain instances;

 

·we must maintain a minimum standard of customer service, including, among other things, establishing call centers, maintaining a certain service level (both coverage and performance) of our network, collecting payments pursuant to a certain procedure, protecting the privacy of subscribers; use a specific format for our agreement with our customers; obtain an explicit request from our subscribers to purchase services, whether by us or by third parties, as a precondition to providing and charging for such services, including specific requirements as to format and a default blockage of the customer's ability to purchase certain services; maintain a specific form of evidence of customers' request to purchase our services as a precondition to charging our customers for those services; and provide certain notifications to customers regarding the services ordered and the procedures for handling subscribers' objections as to billing and repayment of overcharged sums;

 

·we may not be transfer, pledge or encumber the license or any part thereof without the prior approval of the Ministry of Communications, and face restrictions on the sale, lease or pledge of any assets used for implementing the license;

 

·we are required to obtain insurance coverage for our cellular activities. In addition, the license imposes statutory liability for any loss or damage caused to a third party as a result of establishing, sustaining, maintaining or operating our cellular network. We have further undertaken to indemnify the State of Israel for any monetary obligation imposed on the State of Israel in the event of such loss or damage. For the purpose of guaranteeing our obligations under the license, we have deposited a bank guarantee in the amount of NIS80 million with the Ministry of Communications, which may be forfeited in the event that we violate the terms of our license;

 

·we must maintain and follow a business continuity plan and a disaster recovery plan; and

 

·network sharing, if approved, is to be carried out in accordance with specific instruction in our license;

 

In the event that we violate the terms of our license, we may be subject to substantial penalties, including monetary sanctions. In August 2012, the Communications Law was amended so as to set gradual financial sanctions on communication operators, for breach of their licenses, the sum of which shall be calculated as a percentage of the operator's income and based on the gravity of the breach. The maximum amount per violation that may be

 

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imposed is approximately NIS 1.6 million plus 0.225% of our annual revenue for the preceding year. The Ministry of Communications published criteria to be used for determining the sum of the imposed sanctions, including the impact on the competition, the duration of the violation, the number of subscribers affected, the benefit to the operator from the violation and prior violations. Following the publication of the guidelines, the MOC has substantially increased its supervision activities and imposed monetary sanctions, including on us (in immaterial sums). Substantial sanctions will harm our results of operations. In the event that we materially violate the terms of our licenses, the Ministry of Communications has the authority to revoke them.

 

In July 2014, the Israeli Ministry of Communications published a hearing regarding 2G and 3G networks' coverage and quality requirements. The requirements proposed are more severe than the existing requirements and if adopted may adversely affect our result of operations.

 

In August 2014, the Ministry of Communications published a hearing regarding roaming services provided to subscribers. The hearing proposes, in order to increase competition and reduce roaming payments by subscribers, among others, to allow other Israeli telecommunication operators, including other cellular operators, mobile virtual network operators, international calls operators and landline operators to offer roaming services to a cellular subscriber of another cellular operator, while abroad, using the subscriber's usual cellular number as well as change the way payments for roaming services are calculated. See additional details under "-Tariff Supervision" below. The effects of the changes proposed vary significantly depending on the alternative adopted. The adoption of some alternatives may have a material adverse effect on our results of operations.

 

In August 2014, the Ministry of Communications proposed to amend the Israeli Communications Law and set fixed compensation in case of failure to meet response times and the Minister of communications proposes to set for telecommunications operators' call centers, as well as a fixed compensation in case a subscriber was wrongfully overcharged (more severe than the existing provision to that effect in the Israeli Consumer Protection Law). We estimate that the proposed changes, if adopted as proposed, would have a material adverse effect on our results of operations.

 

As a result of a rights offering effected by IDB in February 2015 and the subsequent purchase of IDB shares previously indirectly held by Mr. Ben Moshe, one of IDB's controlling shareholders at the time, by corporations controlled by Mr. Elsztain, the other controlling shareholder in October 2015, the control of IDB and consequently indirectly of us, has changed and requires the approval of the Ministry of Communications. For additional details, see "Item 3. Key Information – D. Risk Factors - Risks Related to our Business – There are certain restrictions in our licenses relating to the ownership of our shares. As a result of a change in control of IDB, we are currently not in compliance with the terms of our licenses" and "Item 7. Major Shareholders and Related Party Transactions – A. Major Shareholders".

 

Other licenses

 

Unified license

 

In July 2015, Cellcom Fixed Line Communications L.P., or Cellcom Fixed Line, a limited partnership wholly-owned by us, was granted a non-exclusive unified general license,

 

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allowing the provision of landline telephone communications services and replacing its former special general license for the provision of landline communications services granted in April 2006. The license expires in April 2026, but may be extended by the Ministry of Communications for successive periods of 10 years. The partnership deposited a bank guarantee in the amount of NIS 2 million with the Ministry of Communications upon receiving the license. The provisions of our cellular license , including as to its extension, generally apply to the unified license, subject to certain modifications.

 

The unified license allows its holder to provide any of the aforementioned services as well as MVNO services, ISP services (currently provided under an internet service provider license) and installation and maintenance of telecommunication equipment at a customer's or the licensee's premises (currently provided under a "network end point" license), subject to the inclusion of a relevant appendix in the unified license and it is intended to alleviate the requirements on license holders that are not required to have a nationwide infrastructure, in order to decrease entry barriers for additional competitors to enter those markets.

 

The unified license was also granted to 013 Netvision, our indirect wholly owned subsidiary, and one of its subsidiaries, replacing the general license for the provision of international telecommunication services, special licenses for the provision of ISP services and "network end point" and a special general license for the provision of landline telephone services.

 

The unification process of our unified licenses into one license and its timing is yet to be determined in coordination between the Ministry of communications and the operator and may have various legal, financial, tax and accounting implications on our operations to the extent it would require the transfer of assets, goodwill, rights and obligations among the companies in our group or require an operational unification. The provision of several services by one entity would also circumvent the limitations on discrimination between operators.

 

Data and transmission license

 

In 2000, we were granted a non-exclusive special license for the provision of local data communications services and high-speed transmission services, which is effective until December 2017. Following the grant of a special general license for the provision of landline telephone communications services to Cellcom Fixed Line, which also includes the services previously provided through our data and transmission license, our data and transmission license was amended in June 2006 to permit only Cellcom Fixed Line to be our customer of these services (and these services are now being provided to our customers through Cellcom Fixed Line). The provisions of our general and general specific licenses described above, including as to their extension, generally apply to this license, subject to certain modifications.

 

Services in Judea and Samaria

 

The Israeli Civil Administration in Judea and Samaria granted us non-exclusive licenses for the provision of cellular and landline services to the Israeli-populated areas in Judea and Samaria. Those licenses are effective until December 31, 2017. We expect we will be able to renew this license without undue burden. The provisions of the cellular and landline licenses described above, including as to its extension, generally apply to those licenses, subject to certain modifications.

 

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ISP license

 

In December 2001, we were granted a non-exclusive special internet services provider, or ISP, license for the provision of internet access services. The license is effective until December 2018 but may be extended by the Ministry of Communications for successive periods of five years. The provisions regarding the transfer of our shares that are included in the special license for the provision of data and transmission services described above, generally apply to this license.

 

Tariff supervision

 

Under the Israeli Communications Regulations (Telecommunications and Broadcasting) (Payment for Interconnecting), 2000, interconnect tariffs among landline operators, international call operators and cellular operators are subject to regulation. In September 2010, the regulations were amended to dramatically reduce maximum interconnect tariffs payable to cellular operators, leading to a material decrease in our revenues.

 

As of 2013, we are prohibited, under the Communications Law, from making any linkage between a cellular services transaction and a handset purchase transaction, including by way of offering airtime rebates or refunds for handsets. This has resulted in decreased sales of handsets by us and increased churn. In November 2013, the MOC instructed the discontinuance of any specific rebates and refunds to customers transferring from other cellular operators.

 

The Communication Law has prevented the collection of early termination fees in plans with a commitment to a predefined period, or Early Termination Fees, in the cellular market (as of 2012) and the other communication markets (as of 2011) (excluding from customers with more than a certain amount of cellular lines or over a certain amount of monthly invoice for bundles or other services) in existing as well as new pricing plans. An additional amendment to the Law prohibits the collection of the handset's remaining installments in one payment pursuant to early termination. This has led to materially increased churn rate and subscriber acquisition and retention costs and subsequently to accelerated price erosion.

 

Under the Communications Law, if a new operator or Hot Mobile and the hosting operator for national roaming have not reached an agreement as to the terms of the service (including the consideration), for any reason, until the service is to commence (after certain criteria is met) the service will be provided for the then prevailing interconnect tariff (in case of a call and for data services - 65% of the interconnect tariff per 1 mega) and subsequently (but no later than February 1, 2012) shall be determined by the Ministry of Communications with the consent of the Minster of Finance and applied retroactively. Unfavorable terms and consideration for the service, may result in material adverse effect on our results of operations. In October 2011, we entered a national roaming agreement with Golan and in September 2011, Hot Mobile entered a national roaming agreement with Pelephone and later with Partner (which was later replaced by a network sharing agreement by Hot Mobile and Partner).

 

Under the Communications Law, in the event that a MVNO and the cellular operator, will not have reached an agreement as to the provision of service by way of MVNO within six months from the date the MVNO has approached the cellular operator, and if the Ministry of Communications together with the Ministry of Finance determine that the failure to reach an

 

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agreement is due to unreasonable conditions imposed by the cellular operator, the Ministry of Communications may intervene in the terms of the agreement, including by setting the price of the service. In November 2014, the Ministry of Communications published the principles for reviewing the reasonability of MVNO hosting agreements, including existing agreements which the MVNO request to update if the existing agreement hinders its ability to compete and the parties fail to reach an agreement as to its update, to be carried out in light of the best offer made by the cellular operator to a business customer. Unfavorable terms and consideration for the service, may result in material adverse effect on our results of operations. For additional details see "Mobile Virtual Network Operators" below. To date, five MVNOs commenced operations after entering hosting agreements (two of them - Alon Cellular and Home Cellular - were purchased in 2015 by their hosting MNO – Pelephone and us, respectively. Our purchase of Home Cellular is subject to the approval of the Ministry of Communications).

 

As of January 2013, we are obligated to pay our customers predetermined damages for each discrepancy from the customer's pricing plan, remedied after the customer complained, under the Consumer Protection Law. The damages are in an insignificant amount, but may aggregate to substantial amounts if paid to numerous customers on multiple occasions. In August 2014, the Ministry of Communications proposed a bill aiming to impose substantially increased predefined damages for any discrepancy from the customer's pricing plan, which may aggregate to substantial sums if paid to numerous customers on multiple occasions.

 

In August 2013, the Communication law was amended so as to authorize the Minister of Communications to give instructions and to set interconnect tariffs and usage of another operator's network rates and supervised services prices, based not only on previous method of cost (according to a calculation method determined by the Minister of Communications) plus reasonable profit, but also on the basis of one of the following: (1) payment for services provided by a licensee; (2) payment for a comparable service; or (3) comparison to such services or interconnect tariffs in other countries. In addition, the Minister of Communications was authorized to give instructions in relation to structural separation for the provision of different services, including between services provided to a licensee and services provided to a subscriber.

 

In August 2014, the Ministry of Communications published a hearing regarding roaming services provided to subscribers. The hearing proposes, in order to increase competition and reduce roaming payments by subscribers, among others, to change the way payments for roaming services are calculated, such as by requiring a 1 second unit or 1 KB unit (as applicable) for billing of roaming services while abroad and not charging for certain intervals of the call. The adoption of such proposed changes may have a material adverse effect on our results of operations.

 

Network Sharing

 

In May and July 2014, the Ministry of Communications set certain requirements for the approval of network sharing by the Ministry of Communications, including the following principles: (1) sharing of passive elements of cell sites and active sharing of antennas among all cellular operators are encouraged; (2) active sharing of radio networks using shared equipment and frequencies will be allowed only between an operator with a partial 3G network deployment and an operator with a full 3G network deployment, whereas such sharing will not be allowed for two operators with full 3G network deployment; (3) sharing of transmission from cell sites among operators sharing frequencies is generally allowed; (4)

 

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investing in a 4G network will be considered as meeting an operator's undertaking to deploy a 3G network under certain conditions; (5) approval of active sharing of radio networks using shared equipment and frequencies shall be for a limited period, only if there are at least three independent cellular networks in Israel, and is conditioned upon certain conditions, including: (i) the obligation to allow other operators to join on terms equal to the terms granted to the sharing operator with the smallest market share; (ii) the obligation to host a Mobile Virtual Network Operator without the other sharing operators' consent; (iii) the shared radio network must be operated through a joint entity held equally by the sharing operators, which entity will be required to obtain a license from the Ministry of Communications and will use the frequencies allocated to sharing operators; and (iv) the radio elements of the shared network will be held in equal parts by the sharing operators, and each of the sharing operators will have the right to use other sharing operators' passive infrastructure following termination of the agreement.

 

Our network sharing agreements with Golan were not approved and declared void by us and Golan in our November 2015 agreement to purchase Golan. Our co-operation agreement of passive elements only with Pelephone was approved; however, we have been unable to progress in its execution and we can provide no assurance that such co-operation will occur in the future. Hot and Partner's network sharing agreement was approved and the two begun a joint operation through a joint subsidiary.

 

Permits for cell site construction

 

General

 

In order to provide and improve network coverage to our subscribers, we depend on cell sites located throughout Israel. The regulation of cell site construction and operation are primarily set forth in the Israeli National Zoning Plan 36 for Communications, which was published in May 2002. The construction of radio access devices, which are cell sites of smaller dimensions, is further regulated in the Communications Law.

 

The construction and operation of cell sites are subject to permits from various government entities and related bodies, including:

 

·building permits from the local planning and building committee or the local licensing authority (if no exemption is available);

 

·approvals for construction and operation from the Commissioner of Environmental Radiation of the Ministry of Environmental Protection;

 

·permits from the Civil Aviation Authority (in most cases);

 

·permits from the Israel Defense Forces (in certain cases); and

 

·other specific permits necessary where applicable, such as for cell sites on water towers or agricultural land.

 

National Zoning Plan 36

 

National Zoning Plan 36 includes guidelines for constructing cell sites in order to provide cellular broadcasting and reception communications coverage throughout Israel, while preventing radiation hazards and minimizing damage to the environment and

 

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landscape. The purpose of these guidelines is to simplify and streamline the process of cell site construction by creating a uniform framework for handling building permits.

 

National Zoning Plan 36 sets forth the considerations that the planning and building authorities should take into account when issuing building permits for cell sites. These considerations include the satisfaction of safety standards meant to protect the public’s health from non-ionizing radiation emitting from cell sites, minimizing damage to the landscape and examining the effects of cell sites on their physical surroundings. National Zoning Plan 36 also determines instances in which building and planning committees are obligated to inform the public of requests for building permits prior to their issuance, so that they may submit objections to the construction of a site in accordance with the provisions of the Planning and Building Law. Many local authorities have argued that a building permit issued in reliance on the Plan requires the payment of amelioration charge. In 2013 this position was adopted in principle by an appeal zoning committee. However, in 2014 a district court rejected such claim in relation to another national zoning plan, and the decision was appealed and awaits the Supreme Court's decision. Should the matter be decided against us in appeal zoning committees or by a court of law, the costs of constructing a site will substantially increase.

 

However, National Zoning Plan 36 is in the process of being revised. Currently proposed changes would impose additional restrictions and requirements on the construction and operation of cell sites. In June 2010, the proposed changes were approved by the National Council for Planning and Building and submitted for the approval of the Government of Israel. If the proposed changes are approved by the Israeli Government, they will harm our ability to construct new cell sites, make the process of obtaining building permits for the construction and operation of cell sites more cumbersome and costly, and could adversely affect our existing network and delay the future deployment of our network.

 

Site licensing

 

We have experienced difficulties in obtaining some of the permits and consents required for the construction of cell sites, especially from local planning and building authorities. The construction of a cell site without a building permit (or applicable exemption) constitutes a violation of the Planning and Building Law. Violations of the Planning and Building Law are criminal in nature. The Planning and Building Law contains enforcement provisions to ensure the removal of unlawful sites. There have been instances in which we received demolition orders or in which we and certain of our directors, officers and employees faced criminal charges in connection with cell sites constructed and/or used without the relevant permits or not in accordance with the permits. In most of these cases, we were successful in preventing or delaying the demolition of these sites, through arrangements with the local municipalities or planning and building authorities for obtaining the permit, or in other cases, by relocating to alternate sites. As of December 31, 2015, we were subject to four criminal and administrative legal proceedings alleging that some of our cell sites were built and have been used without the relevant permits or not in accordance with the permits. As of the same date, a small portion of our cell sites operated without building permits or applicable exemptions. Although we are in the process of seeking to obtain building permits for these sites, we may not be able to obtain them and in several instances we may be required to relocate these sites to alternative locations or to demolish them without any suitable alternative. In addition, we may be operating a significant number of our cell sites, in a manner which is not fully compatible with the building permits issued for them, although they are covered by permits from the Ministry of Environmental Protection in respect of their

 

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radiation level. In some cases we will be required to relocate these cell sites to alternative locations, to reduce capacity coverage or to demolish them without any suitable alternative.

 

Based on advice received from our legal advisors and consistent with most Court rulings on the matter and the Israeli Attorney General opinion on the matter (given in May 2008) that the exemption from obtaining a building permit applies to cellular radio access devices, we have not requested building permits under the Planning and Building Law for rooftop radio access devices.

 

Notwithstanding the Attorney General's opinion, in May 2008 the District Court of Tel-Aviv-Jaffa, in its capacity as court of appeals, ruled that our and other cellular operators’ devices do not meet the exemption’s requirements and therefore cannot be relied upon by us and other cellular operators. We and other cellular operators appealed against this ruling to the Supreme Court and the State notified the Supreme Court it concurs with our and another cellular operator’s appeals against the District Court ruling. The State requested that a third operator’s appeal be returned to the District Court for further deliberation on specific questions regarding the interpretation of "rooftop" and the requirement to obtain an extraordinary usage permit in the circumstances of that case in the context of the exemption. The Supreme Court decided to hear our appeal together with two appeals filed in 2008 and 2009, including by the Union of Local Authorities in Israel and certain local planning and building authorities, requesting to argue against the position of the State.

 

In July 2009, the inter-ministry committee established to examine the appropriateness of future application of the exemption according to the Attorney General opinion, published its recommendations for future application of the exemption. While the Ministry of Communications recommended that, given the difficulties in obtaining permits for the construction of cell sites, the exemption should be reviewed after the lapse of one to two years from the approval of the new National Zoning Plan 36, to verify that it provides an adequate solution that allows the cellular operators to provide required communications services, the Ministries of Interior Affairs and Environmental Protection recommended that the exemption be annulled within 6 months from the date of the recommendations.

 

In September 2009, following publication of such recommendations, the Attorney General concluded that the application of the exemption does not balance properly the different interests involved and therefore cannot continue. In March 2010 the Israeli Ministry of Interior Affairs submitted draft regulations setting conditions for the application of the exemption for the approval of the Economy Committee of the Israeli Parliament, which includes significant limitations on the ability to construct radio access devices based on such exemption. Under the Israeli Supreme Court's interim order issued in 2010 at the Attorney General's request and somewhat relaxed in 2011, we, Partner and Pelephone are prohibited from constructing further radio access devices in cellular networks in reliance on the exemption until the enactment of the proposed regulations or other decision by the court, other then the replacement of existing radio access devices under certain conditions, whereas Hot Mobile and Golan are allowed to construct radio access devices in reliance on the exemption, under certain limitations. In December 2015, Hot Mobile and Partner requested, with the Attorney's General approval, further relaxation of the order, to allow them to construct new radio access devices under certain conditions, in furtherance of their network sharing and we have requested a similar relaxation Pelephone has also requested a relaxation of the order. Further, the Attorney General notified the Israeli Supreme Court that a recommendation to enact regulations setting conditions for the application of the exemption is being considered and such regulations may be different than those proposed in 2010. We

 

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are awaiting the Court's decision. Additionally, in November 2008 and again in October 2014, the District Court, in its capacity as court of appeals, ruled that the exemption does not apply to radio access devices, if the rooftop on which those devices are located is at the same level as a place of residence or other building that is regularly frequented by people. Other appeals relating to the exemption, including as to the requirement to obtain an extraordinary usage permit, are still under consideration, as well as other claims asserting that those cell sites and other facilities do not meet other legal requirements continue.

 

An annulment of, or inability to rely on, or substantial limitation of, the exemption, the dismantling of radio access devices and cell sites due to reasons out of our control and the objection of some local planning and building authorities to grant due permits where required, could have a negative impact on our ability to obtain environmental permits for these sites, could negatively affect the extent, quality, capacity and coverage of our network (specifically in urban areas), and our ability to continue to market our products and services effectively and may have a material adverse effect on our results of operations and financial condition.

 

Radio access devices do receive the required permits from the Ministry of Environmental Protection. Since October 2007, the Commissioner of Environmental Radiation at the Ministry of Environmental Protection took the position that he will not grant and/or renew operating permits to radio access devices, where the local planning and building committee’s engineer objected to the Company's reliance upon this exemption for radio access devices. We believe that in taking this position, the Commissioner is acting beyond his powers.

 

Several local planning and building authorities argue that Israeli cellular operators may not receive building permits in reliance on the current National Zoning Plan 36, or the Plan, for cell sites operating in frequencies not specifically detailed in the frequencies charts attached to the Plan. In a number of cases, these authorities have refused to issue a building permit for such new cell sites, arguing that the Plan does not apply to such cell sites and that building permits for such cell sites should be sought through other processes (which are longer and cumbersome), such as an application for an extraordinary usage or under existing local specific zoning plans. Since June 2002, following the approval of the Plan, building permits for the Company's cell sites (where required) have been issued in reliance on the Plan. The proposed draft amendment to the Plan covers all new cell sites requiring a building permit, independently of the frequencies in which they operate. Most of our cell sites and many cell sites operated by other operators, also operate in frequencies not specifically detailed in the Plan. The frequencies allocated in the 2011 UMTS tender to Hot Mobile and Golan as well as the frequencies awarded under the January 2015 4G frequencies tender, are also not detailed in the Plan. We believe that the Plan applies to all cell sites, whether or not they operate in specific frequencies.

 

If this approach continues, it would have a negative impact on our ability to deploy additional cell sites (until such time as the Plan is amended to include all cellular cell sites), which could negatively affect the extent, quality and capacity of our network coverage and our ability to continue to market our products and services effectively.

 

In addition to cell sites, we provide repeaters (also known as bi-directional amplifiers) and femto-cells to subscribers seeking a solution to weak signal reception within specific indoor locations. Based on advice received from our legal advisors, we have not requested building permits under the Planning and Building Law for outdoor rooftop repeaters, which

 

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are a small part of the repeaters that have been installed. It is unclear whether other types of repeaters and femto-cells require building permits. Some repeaters and femto-cells require specific permits and others require a general permit from the Ministry of Environmental Protection in respect of their radiation level, and we ensure that each repeater functions within the parameters of the applicable general permit. Should it be established that the installation of repeaters and femto-cells (including those already installed) requires a building permit, we will perform cost-benefit analyses to determine whether to apply for permits for existing repeaters or to remove them and whether to apply for permits for new repeaters or femto-cells.

 

In addition, we construct and operate microwave sites as part of our transmission network. The various types of microwave sites receive permits from the Ministry of Environmental Protection in respect of their radiation level. Based on advice received from our legal advisors, we believe that building permits are not required for the installation of these microwave facilities on rooftops. If the courts determine that building permits are necessary for the installation of these sites, it could have a negative impact on our ability to obtain environmental permits for these sites and to deploy additional microwave sites and could hinder the extent, quality and capacity of our transmission network coverage and our ability to continue to market our landline services to our business customers (based on our own infrastructure) effectively.

 

In August 2014, additional regulations that include a new exemption from obtaining a building permit came into effect. The exemption is afforded to the addition of an antenna to an existing cell site and is subject to receiving the Commissioner of Environmental Radiation approval that such addition does not change the radiation safety range set in relation to such cell site prior to the addition.

 

Operating a cell site or a facility without the requisite permits or not in accordance with permits granted could subject us and our officers and directors to criminal, administrative and civil liability. Should any of our officers or directors be found guilty of an offence, although this has not occurred to date, they may face monetary penalties and a term of imprisonment. In addition, our sites or other facilities may be the subject of demolition orders and claims of breach of contract and we may be required to relocate cell sites to less favorable locations or stop operation of cell sites. This could negatively affect the extent, quality and capacity of our network coverage and adversely affect our results of operations.

 

In July 2011, an inter ministry team of the Ministries of Communications, Finance, Interior, Environmental Protection and the Anti-Trust Commissionaire, published its recommendations regarding cell site sharing. The recommendations include compulsory cell sites sharing in the construction of new cell sites or modification to existing cell sites which require a building permit (the Ministry of Communications may exempt from the obligation to share cell sites where such obligation poses technological and engineering difficulties), while providing preference and leniencies to the new UMTS operators, as well as the reduction of existing non shared cell sites quantity. Unlike the site sharing we wish to implement in the framework of our agreements with Pelephone, where site sharing will be carried out where it is beneficial for us, these recommendations or similar recommendations, if enacted, would further burden the construction of new cell sites and modifications to existing cell sites, and may adversely affect our existing cellular network, network build-out and results of operations.

 

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In May 2012, the positions of the Ministries of Communications, Health and Environmental Protection in relation to the various aspects of the provision of 4G services in Israel were published, in response to a petition to hold a public debate regarding 4G service in Israel and prevent 4G spectrum allocation until such debate is held. The Ministries held the position that 4G services would involve some increase in the level of non-ionizing radiation the public will be exposed to and that in order to minimize such increase 4G deployment should, among others, be based on current cell sites, additional outdoor and indoor small cell sites and, whenever possible, use wireline infrastructure so that data traffic shall be carried mostly through wirelines and not cellular infrastructure. The Ministry of Environmental Protection stated that full deployment of 4G infrastructure, under the guidelines set by the ministries shall decrease the level of exposure from handsets and create a more balanced level of exposure from cell sites, and in any case much lower than the maximum exposure levels recommended by the international health organization and required under the environmental permits for cell sites in Israel. In August 2014, the Ministry of Communications allowed the provision of 4G services and in January 2015, 4G frequencies were awarded to the cellular operators. The abovementioned recommendations were not included in the approval or tender documents. See "Construction and operating permits from the commissioner of environmental radiation" below for additional details.

 

Indemnification obligations

 

In January 2006, the Planning and Building Law was amended to provide that as a condition for issuing a building permit for a cell site, local building and planning committees shall require letters of indemnification from cellular operators indemnifying the committees for possible depreciation claims under Section 197 of the Planning and Building Law, in accordance with the directives of the National Council for Planning and Building. Section 197 establishes that a property owner whose property value has been depreciated as a result of the approval of a building plan that applies to his property or neighboring properties may be entitled to compensation from the local building and planning committee. The limitation period within which depreciation claims may be brought under the Planning and Building Law is the later of one year from receiving a building permit under National Zoning Plan 36 for a cell site and six months from the construction of a cell site. The Minister of Interior Affairs retains the general authority to extend such period further.

 

The National Council’s guidelines issued in January 2006, provide for an undertaking for full indemnification of the planning and building committees by the cellular companies, in the form published by the council. The form allows the indemnifying party to control the defense of the claim. These guidelines will remain in effect until replaced by an amendment to National Zoning Plan 36.

 

Since January 2006, we have provided approximately 400 indemnification letters in order to receive building permits. In addition, prior to January 2006, we provided three undertakings to provide an indemnification letter to local planning and building committees. Local planning and building committees have sought to join cellular operators, including us, as defendants in depreciation claims made against them even though indemnification letters were not provided. We were joined as defendants in a small number of cases, and as of December 31, 2015, we are a party to two depreciation claims for immaterial amounts. We expect that we will be required to continue to provide indemnification letters as the process of deploying our cell sites continues. As a result of the requirement to provide indemnification letters, we may decide to construct new cell sites in alternative, less suitable locations, to reduce capacity coverage or not to construct them at all, should we determine that the risks

 

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associated with providing such indemnification letters outweigh the benefits derived from constructing such cell sites, which could impair the quality of our service in the affected areas.

 

Construction and operating permits from the commissioner of environmental radiation

 

Under the Non-Ionizing Radiation Law (and previously under the Israeli Pharmacists Regulations (Radioactive Elements and their Products), 1980), it is prohibited to construct and operate cell sites without a permit from the Ministry of Environmental Protection. The Commissioner of Environmental Radiation is authorized to issue two types of permits: construction permits, for cell site construction; and operating permits, for cell site operation.

 

These permits contain various conditions that regulate the construction and/or operating of cell sites, as the case may be. Our cell sites routinely receive both construction and operating permits from the Commissioner within the applicable time frames. Some repeaters require specific permits and others require general permits from the Commissioner in respect of their radiation level, and we ensure that each repeater functions within the parameters of its applicable general permit.

 

Pursuant to the Non-Ionizing Radiation Law, the construction and operation of cell sites and other facilities requires the prior approval of the Commissioner. The validity of a construction permit will be for a period not exceeding three months, unless otherwise extended by the Commissioner, and the validity of an operating permit will be for a period of five years and we are required to submit to the Commissioner annual reports regarding radiation surveys conducted on our cell sites and other facilities by third parties that were authorized to conduct such surveys by the Commissioner. Permits that were issued under the Pharmacists Regulations were deemed, for the remainder of their term, as permits issued under the Non-Ionizing Radiation Law. An applicant must first receive a construction permit from the Commissioner and only then may the applicant receive a building permit from the planning and building committee. In order to receive an operating permit from the Commissioner, certain conditions must be met, such as presenting a building permit or an exemption and means taken (including technological means) to limit exposure levels from each cell site or facility (relevant also for the receipt of a construction permit). In April 2010, the Commissioner amended all existing operating permits to include an obligation to provide the Commissioner with online, ongoing data regarding the radiation level on each of the cell sites and other facilities operated by each cellular operator, satisfied by a monitoring system supplied by the Commissioner and installed at the operator's premises. We provide the Commissioner with the requested data. See "Site licensing" above for additional details in regards to obtaining a building permit or relying on an exemption.

 

The Non-Ionizing Radiation Law also regulates permitted exposure levels, documentation and reporting requirements, and provisions for supervision of cell site and other facility operation. The Non-Ionizing Radiation Law grants the Commissioner authority to issue eviction orders if a cell site or other facility operates in conflict with its permit, and it imposes criminal sanctions on a company and its directors and officers for violations of the law. Failure to comply with the Non-Ionizing Radiation Law or the terms of a permit can lead to revocation or suspension of the permit, as well as to withholding the grant of permits to additional cell sites of that operator.

 

In March 2013, a bill amending the Non-Ionizing Radiation Law so as to prohibit the grant of permits under such law for the construction and operation of cell sites situated within

 

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75 meters from certain institutions, passed a preliminary phase of enactment in the Israeli Parliament. According to the bill, such permits granted prior to the enactment of the bill shall expire within 6 months from its effective date. In March 2013, another bill amending the Planning and Building Law was published, so as to broaden the public's right to submit objections to all requests for the construction of cell sites and to allow a wider discretion to the planning authorities in relation to such requests that are submitted in certain circumstances including similar to those described in the previous bill. If the proposed changes to the Non Ionizing Radiation Law or the Planning and Building Law, or similar restrictions are subsequently adopted, they will, among other things, limit our ability to construct new sites (and if applied to existing cell sites, they will also limit our ability to renew operating permits for many of our existing sites), will adversely affect our existing networks and networks build out, specifically in urban areas, and could adversely affect our results of operations.

 

Handsets

 

The Israeli Consumer Protection Regulations (Information Regarding Non-Ionizing Radiation from Cellular Telephones), 2002, regulate the maximum permitted level of non-ionizing radiation from handset that emit non-ionizing radiation, according to the European standard, for testing GSM devices, and the American standard, for testing TDMA and CDMA devices. They also require cellular operators to attach an information leaflet to each handset package that includes explanations regarding non-ionizing radiation, the maximum permitted level of non-ionizing radiation and the level of radiation of that specific model of equipment. The Radiation Regulations further require that such information also be displayed at points-of-sale, service centers and on the Internet sites of cellular operators.

 

We obtained type-approval from the Ministry of Communications for each handset model we started to import prior to November 2012. As of November 2012, we inform the MOC of new models that we start to import and receive the MOC's approval. SAR levels are a measurement of non-ionizing radiation that is emitted by a hand-held cellular handset at its specific rate of absorption by living tissue. SAR tests are performed by the manufacturers on prototypes of each model of handset, not for each and every item. We include the information published by the manufacturer regarding SAR levels as we do not perform independent SAR tests for equipment and rely for this purpose on information provided by the manufacturers. As the manufacturers’ approvals refer to a prototype handset, we have no information as to the actual SAR level of each specific item and throughout its lifecycle, including in the case of equipment repair. We inform our customers that there may be changes in the SAR levels in the event of equipment repair. See "Item 8. Financial Information – A. Consolidated Statements and Other Financial Information – Legal Proceedings – Class Actions" for details regarding two class actions against us, in respect of handsets and accessories.

 

We are required to provide a warranty for certain end user equipment purchased from us, for certain malfunctions during the first year, and are required to provide repair services for two years and in certain cases, for three years. We are also required to annul equipment sale in certain circumstances, at the request of the customer.

 

Royalties

 

Under the Communications Law, the Israeli Communications Regulations (Royalties), 2001, and the terms of our general license, we are required to pay the State of Israel royalties equal to a certain percentage of our revenues generated from telecommunications services,

 

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less payments transferred to other license holders for interconnect fees or roaming services and losses from bad debt. No royalties were due for sale of handsets. As of 2013, that percentage was 0%.

 

Frequency fees

 

Frequency allocations for our cellular services are governed by the Wireless Telegraph Ordinance. We pay frequency fees to the State of Israel in accordance with the Israeli Wireless Telegraph Regulations (Licenses, Certificates and Fees), 1987.

 

Mobile virtual network operators

 

A mobile virtual network operator, or MVNO, is a cellular operator that does not own its own spectrum and usually does not have its own radio network infrastructure. Instead, MVNOs have business arrangements with existing cellular operators to use their infrastructure and network for the MVNO’s own customers. The operation of MVNOs in the Israeli cellular market has contributed to the increased competition. If our service to a MVNO is to be provided under unfavorable terms and consideration for us, it may adversely affect our revenues.

 

For the Minister of Communications' authority to intervene in the terms, including tariffs, for hosting an MVNO, see "Item 4. Information on the Company – B. Business Overview - Government Regulations - Tariff Supervision". Unfavorable terms and consideration for the service may result in material adverse effect on our results of operations.

 

To date the Ministry of Communications has granted eleven MVNO licenses and five MVNOs have entered hosting agreements with cellular operators, without the Ministry of Communications's intervention (Rami Levy, Home Cellular (recently purchased by us, subject to approval of the Ministry of Communications), Alon Cellular (recently purchased by Pelephone), Azi and Cellact), and commenced operations in December 2011 through December 2013. It is unknown if and when the others will commence operations. For additional details see "Item 4. B. – Business Overview – The Telecommunications Industry in Israel – Cellular services".

 

Additional MNOs

 

Hot Mobile (in September 2011) and Golan (In January 2012) were awarded new UMTS frequencies, following a spectrum tender held by the Ministry of Communications. Under the UMTS tender terms, both Golan's and Hot Mobile's commitment to pay license fees was reduced to NIS 10 million, after reaching 7% market share each, in the private sector. Hot Mobile and Golan were awarded certain additional benefits and leniencies, such as a prolonged timetable for network coverage completion and the right to use national roaming through our, Pelephone or Partner's ' networks.

 

Under the Communications Law, existing operators (other than Hot Mobile) are required to provide new UMTS operators and Hot Mobile national roaming services, for a period of seven to ten years (subject to certain conditions). For regulatory intervention in the terms of the national roaming service, including tariffs, in case of inability to reach an agreement, see "Item 4. Information on the Company – B. Business Overview - Government Regulations - Tariff Supervision".

 

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In October 2011, we entered a national roaming agreement with Golan, under which we provide Golan national roaming services and cell site sharing privileges (which was later amended by our agreement for the purchase of Golan), and Hot Mobile entered a national roaming agreement with Pelephone and later with Partner (which was later replaced by a network sharing agreement by Hot Mobile and Partner). As a result, the Ministry of Communications did not determine the terms for the service.

 

In May 2012, Golan and Hot Mobile launched their UMTS services, which materially increased competition in the market, increased churn and accelerated price erosion, and have materially adversely affected our results of operations. Investing in a 4G Network will, under certain conditions, replace Golan and Hot Mobile's obligation to deploy a UMTS network. For additional details see "Network Sharing" above.

 

In January 2015, the Israeli Ministry of Communications completed an 1800MHz frequencies tender, for 4G technologies (such as LTE, LTE Advanced). Participation in the tender was open for all current MNOs, MVNOs and other entities meeting certain condition and bands of 5MHz (excluding our band which was limited to 3MHz given our previous possession of 1800MHz), were awarded to the highest bidders. All existing MNOs and Marathon won bands in the tender and Marathon – a new operator - is expected to be awarded an MNO license. Under the tender terms, Marathon, Golan and Hot Mobile are eligible for up to 50% discount, 10% discount for each 1% addition to their market share, obtained over the next 5 years. We were awarded 3MHz for NIS 6.5 million per 1MHz. Pelephone was awarded 15MHz and each of Partner, Golan, Hot Mobile and Marathon was awarded 5MHZ, for NIS 6.4 – 6.9 million per 1MHz.

 

Landline

 

In May 2012, the Israeli Minister of Communications published a policy document regarding landline wholesale services, which mainly provided for: (1) the creation of an effective wholesale telecommunications access market in Israel, as Bezeq and Hot will allow other operators that do not own an infrastructure, to use their infrastructure in order to provide services to end users; (2) the gradual annulment of the structural separation in the Bezeq and Hot groups and its replacement with an accounting separation and change of the supervision on Bezeq retail tariffs to maximum tariffs rather than the current setting of fixed tariffs, generally depending on the development of a wholesale market and the state of competition in the market, and with relation to television broadcasting services, if there is a reasonable possibility of providing a basic package of television services through the internet by providers without a national landline infrastructure.

 

In January and February 2014, the MOC published hearings regarding terms for the provision of certain wholesale landline services by Bezeq and Hot to other operators (as well as an IRU of passive infrastructure elements by Bezeq and Hot of each other's networks) and the maximum prices it intends to set for certain wholesale services to be provided by Bezeq to other operators (excluding Hot). The MOC noted it is reviewing applying certain wholesale obligations on all landline operators, including us. The MOC further published its decision regarding the types of landline services that shall be offered through the wholesale landline market.

 

In November 2014, the Minister of Communications amended Bezeq's and Hot's Communications' licenses so as to include certain wholesale landline services, such as internet infrastructure services and wholesale landline telephony services, and the terms for the

 

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provision of such services (within 3-6 months from the date of that decision) as well as promulgated regulations setting the maximum tariffs of the wholesale landline services to be provided by Bezeq. In November 2014, the Ministry of Communications further published a hearing proposing a method of inspecting whether Bezeq and Hot reduce their retail tariffs and thereby reduce the difference between the wholesale and retail tariffs ("margin squeeze") for certain landline services, aiming at reducing the profit of operators who do not own landline infrastructure and preventing their operation in the market.

 

In January 2015, the Ministry of Communications further amended Bezeq and Hot's licenses to include additional landline services, such as the use of certain of their physical infrastructure by operators who do not own such infrastructure, and the terms for their provision, as of August 2015. In February 2015, the wholesale landline market was formally launched in Israel (through non-automated operation) in regards to internet infrastructure services and in May 2015 the automated stage of the wholesale landline market was effected in regards to internet infrastructure services. Landline telephony service, which was to be provided as of May 2015, has not been provided yet and in December 2015, the Ministry of Communications published a hearing for an alternative temporary one year resale telephony service, at substantially higher tariffs than those set for the telephony wholesale service. We believe that a resale telephony service is not a viable alternative and that its adoption will harm the competition in the landline market and have therefore objected to its adoption. Further, Although the wholesale market was formally applicable to Hot's infrastructure as well, Hot's infrastructure has been effectively excluded from the wholesale market and in January 2016, the Ministry of Communications published a hearing proposing to set maximum tariffs for Hot's wholesale internet infrastructure services and noting it will not interfere with the tariffs Hot has set for its wholesale telephony service. Effective inclusion of Hot's infrastructure in the wholesale market may increase the potential subscribers to our triple play and bundle offerings.

 

Further, in January 2016 the Ministry of Communications announced its intention to annul Bezeq and Hot's structural separation as part of its plan to ensure massive investment in fiber optics infrastructure in Israel and setting a framework for a wholesale market using such infrastructure. We believe the annulment of structural separation for the Bezeq and Hot will adversely affect our competitive standing, more so if effected before a complete and effective wholesale landline market is operating. For changes to the Israeli Communication law, extending the Minister of Communications' authority to give instructions and set interconnect tariffs, usage of another operator's network rates and supervised services prices, and give instructions in relation to structural separation, see "-Tariff supervision" above.

 

In August 2013, IBC (a company owned by the Israeli Electric Company, or IEC, and an international group led by Via Europa) received licenses for the provision of broadband infrastructure services on the IEC's optic fibers infrastructure to other licenses holders as well as directly to large business customers. In 2014, IBC commenced deployment of its infrastructure and commenced the provision of such services in selected areas. Some of the smaller ISP providers have reportedly entered an agreement with IBC. See also "- Competition – Wireline" above.

 

OTT TV

 

Television services over the Internet are currently not regulated in Israel. In July 2015, a committee nominated by the Ministry of Communications in order to examine, among other things, the regulatory principles and rules that should apply to both television

 

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broadcasting over the internet and the incumbents' TV service over cables and via satellite, submitted its recommendations.

 

In February 2016, a second advisory committee for the regulation of broadcasting nominated by the Ministry of Communications in October 2015, published its interim recommendations for public comments, including: (1) technological neutrality as to the electronic means by which the content is provided; (2) alleviation of regulation of audio-visual broadcasting in certain aspects, to be handled by a new authority to be established (the Commercial Broadcasting Authority); (3) classification of the players in the market into three categories and determination of the regulation applied to each class as follows: (i) an "audio visual provider" shall be allowed to adopt voluntary self regulation, (ii) a "TV provider" (defined as an audio visual provider offering more than 4 linear edited channels or directing its service mainly to the Israeli public) shall be subject to mild regulation involving a mandatory license that shall include certain limitations in relation to content and ownership and a choice of financing between subscription fees or advertisements, and (iii) a "material provider" (defined as an audio visual vendor generally holding market share of 15-20%) shall be subject to the said mild regulation and to a wide regulation which shall include mandatory investments and original Israeli content financing; (4) audio visual providers who own infrastructure shall be obligated, among others, to offer a package of infrastructure, set-top box and open linear channels for a supervised price; and (5) regulation of advertising and commercial content.

 

The implementation of either committee's recommendations is subject to the adoption thereof by legislation. If the legislation adopted require us to make additional investments or impose unfavorable regulation on our OTT TV service, or apply such regulation to us and not to other OTT TV providers, or usage of the DTT infrastructure, it may adversely affect our OTT TV business.

 

See also "- Competition – Wireline" above.

 

Emergency situations

 

We may be subject to certain restrictions and instructions regarding our activities or provision of services during national emergencies or for reasons of national security or public welfare, which may increase our liability, including taking control of our cellular or landline networks. Further, the Prime Minister and the Ministry of Communications may determine that our services are deemed essential services, in which case we may be subject to further additional limitations on our business operations.

 

Reporting requirements

 

We are subject to extensive reporting requirements. We are required to report to the Ministry of Communications the transfer of means of control from certain thresholds and changes of office holders, as well as to provide reports relating to our ongoing operation and services. We are required to submit to the Ministry of Communications detailed annual reports with information concerning subscribers, revenues by service, the number of new subscribers and churn, network performance, annual financial statements and prior notice of tariff increases . In addition, under our license we may be required by the Ministry of Communications to file additional reports, such as reports on complaints, pricing, specific costs and revenues, network problems and the development of the network.We are required

 

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to provide the Commissioner of Environmental Radiation under the Non-Ionizing Radiation Law and regulations with periodic and online, ongoing data of all cell sites operated by us.

 

Securities administrative enforcement

 

Under Israeli securities laws, certain violations of certain securities and securities-related laws supervised by the Israeli Securities Authority, or ISA, may be enforced through administrative measures. The ISA may impose various civil enforcement measures, including financial sanctions, payment to the injured party, prohibition of the violator from serving as an executive officer for a specified period of time, annulment or suspension of licenses, approvals and permits granted under such laws and agreed settlement mechanism as an alternative to a criminal or administrative proceeding. In case of a violation by a corporation, additional responsibility is attributed to the chief executive officer in some cases, unless certain conditions have been met, including the existence and implementation of procedures for the prevention of the violation. We adopted such procedures for the prevention of violations. Since the commencement of operations by the Israeli Securities Law Administrative Enforcement Committee, significant monetary sanctions, ranging up to several million shekels in individual cases, have been imposed on several publicly traded companies and their affiliates for breach of the provisions of the Israeli Securities Law.

 

Contributing to the Community and Protecting the Environment

 

We and our employees have been contributing to the community since our inception. We consider contribution to the community in Israel an important component of our business vision and believe we have a responsibility toward the Israeli community, as we acknowledge that business leadership goes hand in hand with social leadership.

 

In 2015 we continued to contribute to the community with a specific focus on our "Cellcom Volume" youth centers initiative. In addition to promoting Israeli music and artists and providing our customers with Israeli music through a variety of musical content, we have contributed to the creation of "Cellcom Volume" youth centers in various locations throughout Israel, in which we provide young people resources related to music, including music classes, facilities to bands and choirs for rehearsals and recording studios. We are currently reviewing new initiatives of contributing to the community to replace the "Cellcom Volume" initiative.

 

Throughout the year, our employees volunteer in various activities in the community.

 

In addition to our contribution to the building up and strengthening of the community, through activities such as our "Cellcom Volume" youth centers, we make financial donations to other worthy causes and entities. In 2015 we donated a total sum of approximately NIS 4.9 million, including our contribution to the community.

 

We are aware of the importance of environmental protection. Accordingly, while providing quality products and services to our subscribers, we seek to operate responsibly to continuously reduce negative impacts on the environment and the landscape, aiming at a better environmental performance than required by local law. We dedicate personnel, funds and technologies to improve our performance, strive to achieve an efficient deployment of infrastructure subject to the applicable standards, and cooperate with the local authorities. We constantly monitor our environmental performance and aim to reduce our ecological footprint, through activities such as recycling of electronic components and packages,

 

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reduction of paper usage by managed printing, reduction of pollutants' emissions and energy usage as well as activities aimed at allowing our subscribers to better protect the environment, such as collecting used batteries, sending subscribers their monthly bill for our services and other correspondence from us via e-mail and as of 2014, also by SMS, in lieu of regular mail, transfer to usage of environment friendly raw materials and separation between different types of waste in our repair services and since 2014 are purchasing electricity produced by a private natural gas based power station.

 

Netvision

 

General

 

On August 31, 2011, we completed the acquisition of 100% of the share capital of Netvision through a merger transaction. Netvision was founded as an Israeli company in 1994 and became a public company following its initial public offering on the TASE in 2005. In our description of Netvision's business, the term "Netvision" refers to Netvision and its subsidiaries.

 

Netvision is a leading company in the Israeli communications market and is engaged in two primary businesses through its wholly-owned subsidiary 013 Netvision Ltd., or 013 Netvision: provision of internet connectivity (ISP) and related services, recently - following the formation of the landline wholesale market – combined with internet infrastructure services; and provision of telephony services consisting mainly of international calling services, operator services, teleconferencing services and landline telephony services. In addition, Netvision is engaged in additional activities such as internet applications, cloud services and data security products.

 

Internet infrastructure and ISP Business

 

General

 

The provision of internet connectivity services is one of Netvision's primary businesses. Netvision is a major provider of internet connectivity services. Prior to the formation of the landline wholesale market, the Israeli internet market was characterized by a separation between the internet infrastructure providers and the internet connectivity service providers. Consequently, the internet customer was required to enter into a contractual arrangement with both of these providers. The infrastructure provider is responsible for the connection of the customer from his computer or other device to the infrastructure provider's operator. The internet service provider is responsible for providing access to the customer from the infrastructure provider's operator, through its own operator, to the local and global internet network. Following the inception of the landline wholesale market, we, Netivsion and other operators provide end-to-end internet service (infrastructure and connectivity), using Bezeq's VDSL infrastructure. The two main internet infrastructure providers having their own landline infrastructure for the private sector in Israel are Bezeq and Hot, both are currently under certain structural separation limitations. Bezeq is also providing internet infrastructure services to operators that do not own their own infrastructure (such as Netvision) under the landline wholesale market, who, in turn, provide this service to the end customer. Netvision's internet infrastructure is currently comprised of connectivity sites in two locations in Israel (Haifa and Petah-Tikvah), which provide Netvision's customers, through overseas connectivity points in London and Frankfurt, with connectivity to the global internet network. This internet infrastructure contains backup capability in order to ensure continuity of service.

 

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For a details regarding the landline wholesale market see "Business Overview -Competition - Wireline" and "Government Regulation – Landline" above.

 

Services and Products

 

Netvision's main service provided to its internet subscribers is internet connectivity service and related services and products, and as of May 2015, also internet infrastructure services bundled with internet connectivity, as well as bundles of its services, including bundling with our services and other companies' products or services.

 

In addition, Netvision offers its internet subscribers value added services, such as data protection services to its private subscribers and connectivity integration solutions and global communications solutions to its business customers, including firewalls, anti-virus and anti-spam software, overseas internet connectivity services and server hosting services. In addition, Netvision provides ISP services that offer the ability to filter the content viewed by the internet users.

 

Netvision is constantly considering and evaluating the possibility of introducing additional products and services to its customers.

 

The Israeli ISP market is characterized by rapid technological changes, both in terms of the bandwidth offered to customers, as well as in terms of expansion of the list of products and services offered.

 

Suppliers

 

In the course of engaging in its ISP business, Netvision has entered into agreements with various suppliers, of which the principal agreements are the following:

 

Netvision has entered into a number of agreements with Mediterranean Nautilus Ltd. and Mediterranean Nautilus (Israel) Ltd., or collectively Med Nautilus, between 2003 and 2015. Med Nautilus is the owner of communications infrastructure which connects the Israeli internet network to the "entry points" of the global internet network via an underwater communications cable (out of three existing cables, one of them is owned by one of Netvision's competitor, Bezeq International). Pursuant to its agreements with Med Nautilus, Netvision purchased rights of use, of certain telecommunications capacities on Med Nautilus' communications cables, as well as maintenance and operation services relating to these cables. Over the last few years Netvision has increased the capacity purchased for significantly lower prices, as well as reduced maintenance costs. The term of the agreement with respect to capacity purchased from Med Nautilus is in effect until May 2032. Netvision has the option to terminate agreements with respect to parts of the capacity in 2022 and 2027. The terms of these agreements may be subject to regulatory intervention – see "- Regulation and Licenses" below.

 

Netvision has also entered into agreements with Bezeq and Hot, the primary internet infrastructure providers in the Israeli market. Netvision is dependent upon these suppliers since without their infrastructure Netvision would be unable to provide its ISP services to its customers. Due to the increase in customer demand for broadband width in recent years, Netvision is required from time to time to increase the capacity it purchases from Bezeq and Hot. In 2015, we entered into an agreement with Bynat, for the provision of maintenance and proactive malfunction detection and consultant services for Netvision's IP network equipment by Cisco, effective until the end of 2019. In addition, Netvision sells various Cisco products to its customers.

 

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Netvision uses several supporting systems for the provision of service to its customers, including communications infrastructure by Nortel (see additional details under "Telephony Business – Suppliers" below), customer relations management system by PeopleSoft supported by Amdocs, inventory and suppliers management system by Priority/Eshbel, billing system by CBP supported  by Amdocs and by Intec, financial system by Coda and infrastructure integrations system by Microsoft BizTalk. In July 2013, we transferred Netvision's inventory and suppliers management operation to our ERP solutions provided by SAP, supported by Rimini. We are considering the replacement of both our and Netvision's CRM system with one system that shall serve both companies. For details see "Item 4. Information on The Company –B. Business Overview – Network and Technology - Information technology".

 

Netvision's internet infrastructure service is dependent on Bezeq and in case Netvision purchases such services from Hot, it will be dependent on Hot as well. The terms of the service are mainly set in the landline wholesale market regulation. For additional details see "Government Regulation – Landline".

 

Sales and Marketing and Customer Care

 

Netvision conducts its sales and marketing activities in the Internet infrastructure and ISP business through various channels, including media advertising in internet concentrated sales campaigns, telemarketing to potential customers, as well as targeting existing customers by offering them upgrades to existing subscription programs and value added products and services. In addition, Netvision regularly collaborates with other telecommunications providers (including Bezeq and Hot) in order to offer service packages to existing and potential customers and its services are also marketed by Cellcom, including in bundles of services.

 

Netvision's sales and customer care center is located in Haifa, with additional teams located in our headquarters in Netanya, providing sales services, technical and support services, billing and general information, by specializing representatives as well as installation services provided by technicians teams at the infrastructure customers' premises. In addition, Netvision provides its subscribers and potential subscribers with various self-service channels, such as IVR, web-based services, automatic and live chat and mobile phone application where they can receive general and specific information.

 

Competition

 

Internet access is currently provided by three major Internet service providers, or ISPs: Netvision, Bezeq International, Smile Telecom (a subsidiary of Partner), and some other smaller players including Hotnet (a subsidiary of Hot). As of December 31, 2015, Netvision provides ISP services to approximately 685,000 households and we estimate Netvision's market share to be 27%, and Bezeq International and Smile Telecom holding 40% and 24% market share, respectively.

 

The Israeli ISP market is highly competitive and saturated and is characterized by relatively low entry barriers. Competition among the various players concentrates mainly on the ability to offer high-speeds of internet connection and on pricing. Although the provision of ISP services requires obtaining a license from the Ministry of Communications, the Ministry's policy is liberal in granting ISP licenses (and more recently unified licenses, which allow the provision of ISP services to any holder of such license, subject to the inclusion of

 

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an ISP appendix). As a result, as of the date of this report, there are a few dozen holders of ISP licenses (or unified license allowing the provision of ISP services) in Israel, though most of them do not hold significant market shares. Entry into the ISP market requires, however, incurring substantial penetration costs associated with the formation of ISP infrastructure, support systems, customer care systems and marketing channels. Due to such penetration and the other ongoing costs of operating ISP service, profitability in the ISP market usually requires creation of a broad customer base and the ability to sell added value products and high speed packages to the customers.

 

The key success factors in the ISP market are the services included in the bundle, competitive pricing, brand recognition and reputation, advanced and updated technological capabilities, available bandwidth, high levels of customer care service, the ability to constantly develop innovative products and services and complementary products and services, and achieving and maintaining customer loyalty.

 

Although both Bezeq and Hot are under structural limitations, they are allowed to offer bundles of services, under certain limitations, including that some of the services in the Bezeq bundle would be available for sale separately under the same terms as in the bundle, and the requirement that Bezeq allows its competitors to participate in a similar bundle (if it includes ISP, VOB or ILD services) under the same terms and equally markets such bundles as its own bundle (though the second requirement does not apply to the sale of the bundle by a subsidiary of Bezeq). The same limitations apply to Hot in the case of bundles that include ISP services, with respect to the ISP service component of the bundle. The entry of Hot (through its subsidiary Hotnet) into the ISP market at tariffs significantly lower than market prices in 2012, the subsequent entry of cellular operators into that market in 2013, the offering of bundles of services and the aggressive campaigns of both Bezeq and Hot offering substantially higher bandwidth for lower tariffs to end-users, resulted in substantial decrease in ISP service prices and led to increased demand for greater bandwidth, which required Netvision to increase the capacity it purchases from Bezeq and Hot. Further, the offering of bundles of internet infrastructure and ISP using the wholesale market increased the competition in this field, resulting in loss of ISP customers to Netvision. If competition remains at current levels and the regulatory environment remains unchanged, this trend is expected to continue to have a material adverse effect on Netvision's results of operations.

 

In 2011 and 2012, two additional underwater cables that serve as an alternative to Med Nautilus were deployed. In addition, proposed regulation published for public comments by the Ministry of Communications in 2011, proposed certain limitations on the terms of agreements with Med Nautilus, which would, among other things, limit the discounts and capacity Med Nautilus may provide. The deployment of additional underwater cables improved the competition in the ISP market, as ISP providers were able to find alternatives to Med Nautilus, which led to a substantial decrease in the pricing of the global internet connectivity services provided to Israeli ISP providers. In addition, should the IBC infrastructure be available (which currently cannot be assured), this would improve Netvision's competitiveness in the ISP and landline markets as this is likely to reduce its dependency on Bezeq and Hot as internet infrastructure providers.

 

For details regarding the internet infrastructure service market, see "Business Overview -Competition - Wireline".

 

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For additional details see "Item 3. Key Information – D. Risk Factors – - Risks Related to our Business – We face intense competition in all aspects of our business" and " Business Overview – Competition" above.

 

Regulation and Licenses

 

A major part of Netvision's ISP operations is subject to regulation by the Israeli Ministry of Communications pursuant to the Communications Law, including through its unified license.

 

The provision of ISP and related services requires a license. Netvision was granted three ISP licenses, one to its wholly-owned subsidiary 013 Netvision, one to its controlled subsidiary Internet Rimon, and third was granted to 013 Netvision by the Israeli Civil Administration in Judea and Samaria in respect of this territory. The license granted to 013 Netvision was replaced in February 2016 with a unified license. The licenses are valid through February 2022, November 2017 and July 2016, respectively.

 

Under its ISP license, Netvision (Rimon) is required to maintain a minimum standard of customer service and is prohibited from conditioning the use of its services by the customer on the customers being connected to a portal designated by it. Netvision is also required to inform its customers regarding the main features of the service provided, including commencement date of service, the consideration paid by the customer, the minimal surfing speed it is solely responsible for (if it publishes the maximum speed), quality standards, and maintenance details, and details about the possibility of email address portability, and is required to use a specific format for Netvision's agreement with its customers; to obtain an explicit request from its subscribers to purchase services as a precondition to providing and charging for such services; to maintain a specific form of evidence of customers' request to purchase its services as a precondition to charging its customers for those services, provide notifications regarding the services ordered and the procedures for handling subscribers' objections as to billing and repayment of overcharged sums.

 

Under its ISP licenses, Netvision may not transfer any means of control or any of its licenses-related assets without the prior written approval of the Ministry of Communications. The license may be terminated in case that Netvision fails to provide information or provides false information or in case it is engaged in anticompetitive practices in the communications market, subject to certain terms. The licensee is required to provide the Ministry of Communications with certain reports and is required to cooperate with the supervisory bodies of the Ministry of Communications.

 

For additional details regarding the unified license which may facilitate the entry of additional players into the ISP market, see "-Government Regulations - Unified license" above.

 

Further intervention by the Ministry of Communications in the ISP market, including by means of granting additional licenses allowing the provision of such services and setting their terms and conditions, change or annulment of the structural separation currently in place for the Bezeq and Hot groups, permitting the bundling of certain services without restrictions and intervening in the purchasing of global internet connectivity, could have a material adverse effect on Netvision's ISP business.

 

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Telephony Business

 

General

 

The provision of telephony services is one of Netvision's primary businesses. Netvision's services in its telephony business consist mainly of the following:

 

·provision of international calling services, or ILD services;

 

·provision of landline telephony services, including teleconferencing services; and

 

·sales of IP switchboard services and operation and management of business telecommunications systems.

 

ILD services enable an end user (whether in Israel or overseas) to conduct a telephone conversation with an end user located elsewhere in the world. These include calls (including cellular calls) from Israel to various destinations abroad as well as call (including cellular call) completion services to overseas operators transferring a call to Israel; transferring international calls between operators and signaling services to local and foreign cellular operators to allow roaming.

 

Netvision is one of the major players in the Israeli ILD market. In recent years, the ILD market has substantially decreased and is expected to continue to diminish, due to increased usage of substitute solutions, including voice over IP technologies offered by companies such as Skype, usage of local cellular services and increased usage of data in lieu of voice communication. Together with the offering of ILD services for no additional cost in bundles of cellular and landline telephony services, this has resulted in a continual decline in revenues from traditional ILD services.

 

Landline telephony service enables an end user to conduct a telephone conversation with another end user who uses either another landline or a cellular telephone or computer, either in Israel or overseas.

 

Services and Products

 

Netvision's principal service in the ILD market is the provision of outgoing and incoming telephone calls to and from substantially worldwide coverage. Netvision provides these services mostly to post-paid customers, but also to pre-paid customers mainly through the sale of calling cards. Most of the customers of the pre-paid services are foreign workers who work in Israel. In addition, Netvision provides "Hubbing" services to non-Israeli international operators. Hubbing services are bridging services between two non-Israeli international operators. Such services are provided by Netvision where there is no direct connection between two non-Israeli international operators or where pricing differences in different locations make such bridging service desirable. The hubbing service market has been growing in the past few years because of the development of the international dialing market and because of the development of the corresponding arbitrage market on which various international operators trade international dialing capacities. In addition, Netvision provides "signaling" services to cellular operators who use roaming services. A cellular handset located out of its home network needs to "signal" its location to the hosting network in order to enable the cellular subscriber to have roaming services. Netvision provides these

 

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services to certain cellular operators in Israel (including us), as well as to foreign cellular operators with respect to their customers when they visit Israel.

 

Netvision's principal service in the wireline market is the provision of basic landline telephony services (to private customers by VOB technology). Netvision offers these services to both business and private customers. In addition, Netvision offers IP switchboard services and operation and management of business telecommunications systems. Netvision's ILD and landline services are also bundled with cellular services offered by Cellcom and following the inception of the landline wholesale market, Netvision's landline telephony (VOB) is also offered by Cellcom in its triple play package of internet infrastructure and ISP service, landline telephony service and TV service). For additional details see "Business Overview - Competition".

 

Suppliers

 

Netvision's principal suppliers in the telephony market are the following: Bezeq, Hot and cellular operators. Under the Communications Law and licenses, all operators are required to interconnect their network to other public communications networks in Israel, on equal terms and without discrimination in respect of other operators. Netvision has entered into interconnect agreements with Bezeq, Hot and the cellular operators, for facilitating international traffic between Netvision's network and the other networks, as well as for billing and collection services for Netvision services, for certain customers. Netvision's traffic requires interconnections with these operators and is dependent on their availability and quality.

 

Most of the international dialing traffic between Israel and the rest of the world is conducted through the underwater communications cable of Med Nautilus. For further details on the agreements between Netvision and Med Nautilus, see "Netvision - Internet infrastructure and ISP Business - Suppliers" above.

 

Netvision has also entered into agreements with more than 100 foreign carriers. These agreements regulate and facilitate the ILD services of Netvision, as well as its international voice hubbing services.

 

Netvision entered into an agreement with Nortel Networks Israel (Sales and Marketing) Ltd., or Nortel, in June 2004, for the provision of Netvision's international communications switch, on which Netvision bases its ability to provide international calling service, as well as related equipment and services. From 2010, Geneband Inc. (which acquired Nortel's relevant business) provides Netvision with support and maintenance services for the equipment provided under this agreement.

 

Netvision has entered into an agreement with ECI Telecom Ltd. for the provision of transmission switches by ECI Telecom among the various location sites of Netvision in Israel and overseas, used for its ISP and ILD operations.

 

Sales and Marketing and Customer Care

 

The sale and marketing of Netvision's telephony products and services is conducted mainly through direct means such as telemarketing, mail and email campaigns. In addition, Netvision offers its telephony products and services on a non-exclusive basis through our

 

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bundles and triple play package, various retailers, through outsourced telemarketing centers and through distributors.

 

Netvision's customer care centers and self-service channels provide its telephony services customers the same range of services provided to its ISP customers.

 

Competition

 

The Israeli ILD market is highly competitive, and the competition in the market is based mainly on the operator's ability to offer attractive pricing. The price of an international call is also influenced by the call completion tariff paid to the operator in the call's destination country and increased competition in the destination country leads to a decrease in tariffs for calls to those destinations and thus an increase in the quantity of minutes made to those destinations.

 

Netvision commenced its landline telephony services in 2008 using Voice Over Broadband, or VOB, technology, and since then expanded this business. Netvision's penetration into the landline telephony business is an important element in our ability to offer comprehensive service packages to its and our subscribers. In case landline telephony is effectively included in the landline wholesale market, we may also offer wholesale landline home telephony services to private customers.

 

Regulatory changes in the telephony market such as the inclusion of ILD services in unlimited bundles offered by cellular and landline operators, have increased competition further. The adoption of proposed changes to ILD regulation, which includes the provision of ILD services by landline operators and cellular operators themselves and not through a separate company, as required today would increase the competition in the ILD market and may adversely affect Netvision's results of operations. See "-Regulation and Licenses" below.

 

The key success factors in the telephony market are the services included in the bundle, competitive pricing, which are updated constantly, brand recognition and reputation, advanced and updated technological capabilities, reliable network and high levels of maintenance, quality of human resources including customer care services, and the ability to develop comprehensive products and services packages, to build a substantial customer base, to enhance customers' loyalty and the ability to face competition. In addition, the ability to develop strong strategic relations with foreign international carriers and continuous agreements with them are also key elements in the ILD market.

 

In recent years, the use of alternative telecommunications technologies such as voice-over-IP has resulted in downsizing of the telephony market, especially the ILD services revenues. This trend is expected to continue in the future at a more moderate pace.

 

Netvision is a major service provider in the Israeli ILD market. As of the date of this report, there are several ILD operators in the Israeli market. Netvision's main competitors in this market are Bezeq (through its wholly-owned subsidiary Bezeq International) and Partner (through its wholly-owned subsidiary Smile Telecom). Additional competitors include Xfone Communications Ltd., Telzar International Communications Services Ltd., Rami Levy, Golan and Hot, through wholly-owned subsidiaries or affiliates. At the end of September 2015, Netvision's market share in the ILD market is estimated to be approximately 20%, and Bezeq International, Smile Telecom and Hot holding 35%, 24% and 12% market share, respectively.

 

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Netvision estimates that its current market share in the Israeli landline telephony market is not material, with approximately 138,000 households subscribed to the services as of December 31, 2015. Netvision's main competitors in the landline telephony market are Bezeq and Hot, as well as Partner (through Smile Telecom) and Bezeq International. To our knowledge, Bezeq remains a monopoly in the landline market.

 

A wholesale landline telephony services market and the IBC's infrastructure, if and when made effectively available, will enhance Netvision's ability to compete and allow us and Netvision (as well as our competitors) to provide a wider selection of services at competitive prices, specifically in relation to residential landline services which is currently immaterial. Any changes to the structural separation limitations in the Bezeq and Hot groups and the supervision on Bezeq tariffs, or anti-competitive behavior if not prevented by the regulators, however, could adversely affect Netvision's ability to compete with Bezeq and Hot in general, and in the landline market in particular and may have a material adverse effect on Netvision's results of operation. Competition may intensify if additional competitors enter the market following the establishment of an efficient landline wholesale services market.

 

See also "Item 3. Key Information – D. Risk Factors - Risks Related to our Business – We face intense competition in all aspects of our business" and "Item 4. Information on the Company –Competition - Wireline" and "-Government Regulations – Landline".

 

Regulation and Licenses

 

Netvision's operations in the telephony business are subject to regulation, mostly pursuant to the provisions of the Communications Law and the regulations promulgated thereafter, the Communications Regulations (Telecommunications and Broadcasting) (Procedures and Conditions for the Receipt of General Unified License) – 2010, or the Regulations and to the provisions of its Unified licenses, with respect to its ILD landline telephony businesses,and 'network end point' service.

 

Netvision's unified licenses are held by two of its wholly-owned subsidiaries - 013 Netvision and Veidan Teleconferencing Solutions LP, or Veidan, and expire on May 2025 and March 2026, respectively. Each of 013 Netvision and Veidan deposited a bank guarantee in the amount of NIS 5 million with the Ministry of Communications upon receiving the license. See "Business Overview - Government Regulations – Other Licenses – Unified License" above for additional details.

 

In October 2013, the Ministry of Communications published a hearing regarding a change to the ILD services regulation, which proposes, among other things: to annul the current limitation preventing landline and cellular operators from providing ILD services themselves (rather than through a separate corporation), which if adopted and applied to the Bezeq and Hot groups as well, would result in the annulment of the structural limitations currently imposed on them, in relation to the ILD services; that holders of a special license for the provision of ILD services will not be obligated to provide service to anyone so requesting nor to all the countries in the world; and to annul the restrictions on the cooperation between cellular and ILD operators in relation to prepaid calling cards. In February 2015, a second hearing proposing certain alternatives to the abovementioned proposed changes, to be applied to the Bezeq and Hot groups during an interim period ending upon annulment of structural separation, was published. The adoption of such changes would

 

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increase the competition in the ILD market even further and may adversely affect Netvision's results of operations.

 

In addition to its principal unified licenses, Netvision (through its wholly-owned limited partnership Veidan and wholly-owned subsidiary 013 Netvision) received from the Israeli Civil Administration in Judea and Samaria licenses for the provision of landline ILD and 'network end point' services to the Israeli-populated areas in Judea and Samaria, effective until October 2017, August 2018 and July 2017, respectively. The provisions of the principal licenses described above, generally also apply to those licenses, subject to certain modifications

 

Under its unified licenses, Netvision (through its wholly-owned subsidiary 013 Netvision) may also provide 'network end point' service, i.e., mainly the installation and maintenance of telecommunications equipment at a customer's premises or the licensee's premises, which include telephones, switchboards, telephony cables and related equipment as well as enables Netvision to connect a customer premises, through other license holders, to the public landline network.

 

In addition, as a service provider, Netvision is subject, like us, to the general legislation governing relations between vendors and consumers, including the Consumer Protection Law, 1981.

 

In August 2011, the Communications Law was amended pursuant to which the Early Termination Fees in the ILD and in the landline telephony market were annulled, which led to an increase in competition, churn rates and rate of gross recruitment of subscribers and price erosion.

 

For details of the landline wholesale market and its possible effects see "Competition - Wireline" above and "Item 4. Information on the Company –Competition - Wireline" and "-Government Regulations – Landline".

 

C.ORGANIZATIONAL STRUCTURE

 

The IDB Group

 

Our largest shareholder, DIC, is a majority-owned subsidiary of IDB Development Corporation Ltd., or IDB, one of Israel’s largest business groups. IDB and DIC are public Israeli companies traded on the Tel Aviv Stock Exchange. See "Item 3. Key Information – D. Risk Factors - We are a member of the IDB group of companies, a large and highly regulated Israeli business groups, which may limit our ability to expand our business, to acquire other businesses or raise debt. The effects on us of IDB's financial condition are unclear" for details regarding IDB's financial situation and the footnote to the table under "Item 7.A – Major Shareholders" for information on the holdings in IDB.

 

Netvision and 013 Netvision, our wholly-owned subsidiary and wholly-owned indirect company, respectively, incorporated in Israel, are our only significant subsidiaries.

 

D.PROPERTY, PLANT AND EQUIPMENT

 

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Headquarters

 

In August 2003, we entered into a long-term agreement for the lease of our headquarters in Netanya, Israel. The leased property covers approximately 57,800 square meters, of which approximately 26,000 square meters consist of underground parking lots. The lease is in effect until December, 2022 and is renewable for two additional periods of five years each, upon our notice. In 2015, we sublet a portion of our headquarters to several lessees for a period of up to five years, following the reduction in headcount in our headquarters. The lessees have options to renew the lease for additional periods.

 

Central Laboratory

 

In October 2010, we entered into a long-term agreement for the enlargement of our techno-logistic center, including our new central laboratory, in Netanya, Israel, and the lease thereof. The leased property covers approximately 11,000 square meters. The lease is for a term of ten years from August 2011 and is renewable for an additional period of 5 years, at our option. In case we do not exercise the option we shall be required to pay approximately NIS 11 million. In January 2015, we sublet approximately 1,100 square meters of the leased property, for a period of five years. The lessee has an option to renew the lease for an additional period subject to the renewal of our lease.

 

Netvision Properties

 

Netvision leases two main properties in Israel: one in Haifa and the other in Rosh-Ha'ayin. Netvision uses these properties for its offices, for its call centers, and for its network servers, as well as for equipment storage and until December 2011, has used them as headquarters as well. The Haifa lease covers approximately 8,900 square meters, is in effect until December 2019, may be terminated by Netvision in December 2018 subject to prior notice, and is renewable for three additional periods of two years each, upon Netvision's notice. The Rosh-Ha'ayin lease covers approximately 3,300 square meters, is in effect until December 2017 and is renewable for five additional periods of two years each, upon Netvision's notice. Netvision sublets part of the property in Rosh-Ha'ayin to our wholly-owned dealer and another subsidiary.

 

Electricity

 

In December 2010, we entered into an agreement with Ashdod Energy Ltd. (subsequently assigned to Ramat Negev Energy Ltd.), which constructed a private power plant fueled by natural gas in Israel and commenced purchasing a portion of our electricity from it in 2014. Under the agreement as amended in July 2012, we committed to purchase electricity for the earlier of a period of 15 years from commencement of operations of the power plant or until January 2028, subject to our right to terminate the agreement after six years from the commencement of operations of the power plant under certain conditions.

 

Service Centers, Points of Sale and Cell Sites

 

As of December 31, 2015, we leased 78 service centers, points of sale and other facilities (including those operated by our wholly-owned dealer), which are used for marketing, sales and customer service. Lease agreements for our retail stores and service centers are generally for periods of two to three years, with extension options that vary by location.

 

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In addition, we lease from various parties, including the Israeli Land Authority, or ILA, municipalities and private entities sites for the establishment, maintenance and operation of cell sites for our cellular network. The duration of these lease agreements varies and ranges, in most cases, from two to five years, with an option to extend the lease for successive similar periods. The lease agreements also differ from each other in aspects such as payment terms and exit windows that enable us to terminate the agreement prior to its scheduled expiration. In some of the agreements, the lessor is entitled to terminate the agreement at any time without cause, subject to prior notice. Based on our past experience, we encounter difficulties in extending the term of approximately 7% of the lease agreements for cell sites, which at times results in our having to pay higher rent in order to remain in the same locations or to find alternative sites.

 

In addition, Netvision leases a number of points of presence in Israel that are used for equipment and servers storage and storage of operators and other communications equipment for the provision of landline services, and leases storage space for its servers and equipment in New York City, London and Frankfurt.

 

Authorization Agreement with Land Regulatory Authorities

 

In June 2013, we renewed an authorization agreement with the ILA (which manages the lands of the Development Authority and the Jewish National Fund) that authorizes us to use lands managed by the ILA for the establishment and operation of cell sites. The authorization agreement is effective until 2019.

 

The authorization agreement provides that subject to the receipt of approval from the ILA, we will be entitled to establish and operate cell sites on the lands leased to third parties throughout the agreement’s term. In connection with the authorization agreement we undertook to vacate at the end of the agreement’s term all facilities installed in the authorized area unless the authorization period is extended.

 

Under the authorization agreement, the ILA is entitled to revoke authorizations granted to us in the event of changes in the designation of the land on which a cell site was erected, in the event that we violate a fundamental condition of the authorization agreement, in the event that the holders of rights in the properties on which we erected cell sites breach the agreements between them and the ILA and in the event that the land on which a cell site was erected is required for public use.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following operating and financial review and prospects should be read in conjunction with "Item 3. Key Information – A. Selected Financial Data" and our consolidated financial statements and accompanying notes appearing elsewhere in this annual report. Our financial statements have been prepared in accordance with International Financial Reporting Standards, or IFRS, which differ in certain respects from U.S. Generally Accepted Accounting Principles, or U.S. GAAP. Following our adoption of IFRS, as issued by the IASB, we are no longer required to reconcile our financial statements prepared in accordance with IFRS to U.S. GAAP.

 

This discussion contains forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many important factors, including those set forth under "Item 3. Key Information – D. Risk Factors" and elsewhere in this annual report.

 

A. OPERATING RESULTS

 

Overview

 

General

 

We are the largest provider of cellular communications services in Israel with approximately 2.835 million cellular subscribers as of December 31, 2015, with an estimated market share of 27%, as well as a major ISP and ILD services supplier, through our wholly owned subsidiary – Netvision. In 2015 we have also entered the TV market and the internet infrastructure market (through the recently launched landline wholesale market).

 

Since 2012, our results of operations have been materially adversely affected by regulatory changes, which have also facilitated the entry of additional competitors, a dramatically increased competition (as a result of which our churn rate in the cellular field reached 42% in 2015) and continued price erosion, resulting in a decrease in our EBITDA for 2013, 2014 and 2015 by 23.8%, 4.0% and 32% respectively, in comparison to the previous year. The high level of competition is expected to continue to further adversely affect our results of operations in 2016. Competition may increase further if current trends continue, if the agreement for the purchase of Golan by us is not approved by the regulators, if the landline wholesale market, launched in 2015, is ineffective, if the structural separation imposed on the Bezeq and Hot groups is annulled or further relaxed, or if new competitors enter the communications markets. During that period, we have continually implemented aggressive efficiency measures in order to mitigate those adverse effects, which, in 2014 and 2015, included voluntary retirement plans for employees, in which approximately 380 and 330, respectively, employees have retired and we have recorded expenses in the amount of NIS 39 million and NIS 25 million, respectively, for the cost of these plans. We intend to continue to implement changes in order to continue our efforts to mitigate the adverse effects of the increased competition in all areas in which we operate. We cannot guarantee the success of these measures. Moreover, unionization of our employees may impede the execution of such measures. See "Item 3. Key Information – D. Risk Factors – Risks Related to our Business - We face intense competition in all aspects of our business" and "Item 4. Information on the Company - B. Business Overview – Competition" for additional details.

 

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We earn revenues and generate our primary sources of cash by offering a broad range of communications services, including cellular, ISP, ILD , landline services and OTT TV services. Our cellular services include basic cellular telephone services and data transfer, download and upload, as well as text and multimedia messaging services and advanced cellular content services, which we provide through our 2G and 3G network covering substantially all of the populated territory of Israel and our 4G network launched in 2014. We also provide international roaming services to our subscribers in 181 countries as of December 31, 2015 as well as to subscribers of foreign networks visiting Israel. We offer our subscribers a wide selection of handsets of various leading global manufacturers as well as extended warranty services on most handsets we offer. We have an advanced fiber-optic transmission infrastructure of approximately 1,780 kilometers. Together with our complementary microwave-based infrastructure, our fiber-optic infrastructure connects the majority of our cell sites with the remainder connected using supplemental transmission capacity leased from Bezeq, the incumbent landline operator and Hot. Having our own transmission network enables us to save substantial operating cash lease costs that would be associated with complete reliance on Bezeq’s infrastructure, although these savings are partially offset by maintenance costs and microwave spectrum fees. It also allows us to sell transmission and data services to business customers and telecommunications operators. We provide advanced landline services, to selected landline business customers. Since December 2014 we also offer OTT TV services. In addition, following the acquisition of Netvision in 2011, we provide internet connectivity and related services (ISP) and landline telephony services consisting mainly of international calling services (ILD), operator services, teleconferencing services and landline telephony services. Since May 2015 we and Netvision also offer internet infrastructure services (through the landline wholesale market). We sell our various services on a stand-alone basis or bundled with certain other services offered by Netvision and us which as of May 2015 also included triple play bundles of internet infrastructure and ISP, landline telephony and TV services. Entering a new and penetrated market will require substantial investment and additional operating expenses.

 

Our management evaluates our performance through focusing on our key performance indicators, which include among others: average revenue per user of cellular and landline subscribers, or ARPU, EBITDA (as defined in "Results of Operations"), EBITDA as percentage of revenues, operating income, net income cash flow, number of cellular, landline ISP, internet infrastructure and OTT TV subscribers (both standalone and as a part of a bundle or triple play package), subscriber churn rate, handset sales and profitability and Net Promoter Score, or NPS, (indicating our subscribers’ satisfaction with our services). These key performance indicators are primarily affected by the competitive and regulatory landscape in which we operate and our ability to adapt to the challenges posed.

 

In November 2015, we entered an agreement with Golan and its shareholders for the purchase of 100% of the shares of Golan, for the sum of NIS 1.17 billion. The purchase agreement also includes the terms under which Golan shall continue to purchase national roaming services from us and the parties' agreements in relation to Golan's debt to us regarding the difference between the sum Golan has been paying us and the sum it is required to pay us under the national roaming services agreement for services provided until the end of 2015. The consummation of the purchase agreement is subject to the receipt of regulatory approvals. The purchase of Golan is another step in turning us into a leading telecommunication group that provides high value at low prices to the Israeli consumer and we expect that it will, if approved by the regulators and consummated, among other benefits, increase our cellular subscriber market share and our revenues, provide us with opportunities

 

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to offer our other services and products to Golan's subscribers and provide opportunities for cost synergies. There is no assurance that the purchase agreement shall be approved by the Israeli regulators, which we estimate to be challenging, specifically in light of the strong opposition, led by the Ministry of Treasury, nor as to the consummation of the transaction. If the agreement for the purchase of Golan by us is not approved by the regulators and if we cannot maintain the national roaming revenues we currently enjoy or an equivalent compensation it may adversely affect our revenues and may cause difficulties in the collection of Golan's debt to us. For additional details see "Item 3. Key Information – D. Risk Factors – Risks Related to the Proposed acquisition of Golan Telecom Ltd." and "Item 4. Information on the Company – B. Business Overview –– Agreement for the Purchase of Golan".

 

In February 2015, we entered a collective employment agreement with the Company's employees' representatives and the Histadrut for a term of three years (2015-2017). The estimated cost of the agreement over its term is expected to be approximately NIS 200 million, before tax, based on our forecasts (including approximately NIS 30 million in one time payments paid in the first quarter of 2015). In January 2016, the Histradrut announced a labor dispute in the Company with respect to outsourcing and other employment issues.

 

The Israeli telecommunications market is currently dominated by four communications groups: Bezeq, Hot, Partner-012 Smile and Cellcom–Netvision, with the first two having a full landline infrastructure. While an effective wholesale landline market (launched in 2015) will enhance our ability to compete and extend our service offering, the possible annulment of structural separation and Bezeq's tariffs supervision or other favorable regulatory changes relating to the Bezeq and Hot groups, may have a material adverse effect on our competitive capabilities and results of operation.

 

We intend to drive revenue primarily by: maximizing the benefits of our position as a leading Israeli telecommunications group, offering our customers full and comprehensive mobile and wireline solutions and bundles of services (including triple play) and enhancing our competitive capabilities; retaining our existing subscribers; offering new services that are synergetic to our core businesses; growing wireline service revenues; and attracting new subscribers. We intend to continue our efforts to optimize our costs by implementing further efficiency measures, reducing our expenses and adjusting our operations to the changing market conditions, but cannot guarantee the success of these measures.

 

The communications market and specifically the cellular industry are primarily regulated by the Ministry of Communications. Regulatory changes have had material adverse effects on our results of operations in recent years. See "Item 4. Information on the Company – B. Business Overview - Government Regulations." While our pricing is not generally regulated, certain of our rates and pricing mechanisms are subject to regulation. See "Item 4. Information on the Company – B. Business Overview – Government Regulations – Tariff Supervision."

 

The construction and operation of our cell sites and other transmission facilities are highly regulated and require us to obtain various consents and permits. See "Item 4. Information on the Company – B. Business Overview - Government Regulations—Permits for Cell Site Construction." We have experienced difficulties in obtaining some of these consents and permits and our ability to rely on an exemption from obtaining a building permit was severely limited. Also, we may be operating a significant number of our cell sites in a manner not fully compatible with the building permits issued for them. We do not expect that

 

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the demolition of the facilities currently facing a demolition order would have a material impact on our results of operations and financial condition. Additional restrictions on the construction and operation of cell sites and other facilities may be enacted or we may be required to demolish or relocate these cell sites and facilities, which may adversely affect our existing networks and networks build out, specifically in urban areas, may prevent us from meeting our license requirements and could adversely affect our results of operations.

 

In 2013, 2014 and 2015, we entered network and cell site co-operation and sharing agreements with Pelephone and Golan, respectively. Our cell site co-operation agreement with Pelephone was approved by the Israeli Antitrust Commissioner, however, we have been unable to progress in the execution of the co-operation agreement with Pelephone and we can provide no assurance that such co-operation will occur in the future. Our sharing agreement with Golan did not receive approval by the regulators and was voided in our agreement to purchase Golan, described above. For additional details see "Item 4. Information on the Company – B. Business Overview – Network and Technology - Cell Sites Sharing Agreement".

 

Our profitability is also affected by other factors, including changes in our cost of revenues and selling, marketing, general and administrative expenses, including depreciation and financing expenses.

 

Our results are also impacted by currency fluctuations. While substantially all of our revenues are denominated in NIS, for 2015, approximately20 % of cash outflow was denominated in, or linked to, other currencies, mainly U.S. dollars. Changes to the Israeli CPI, may also impact our results as our debentures (excluding Series E, G and I) and some of our expenses are linked to the Israeli CPI. Any devaluation of the NIS against the U.S. dollar or other foreign currencies will therefore increase the NIS cost of our expenses that are not denominated in NIS or are linked to those currencies and any increase in the Israeli CPI will increase the financial expenses associated with our debentures. We enter into derivative instruments to mitigate the effect of the various market risks associated with these expenses. See "Item 11 - Quantitative and Qualitative Disclosures About Market Risk."

 

Further, we have incurred significant debt by issuing debentures, the aggregate outstanding principal amount of which as of December 31, 2015 was NIS 3,788 million. See "- Liquidity and Capital Resources- Debt Service". For details regarding our deferred loan agreements see "- Liquidity and Capital Resources- Other Credit Facilities"

 

In February 2006, our Board of Directors adopted a policy to distribute each year at least 75% of our annual net income. In March 2007, our Board resolved to distribute dividends within the boundaries of the February 2006 dividend policy and until resolved otherwise, on a quarterly basis. In respect of 2015, our board of directors chose not to declare dividends given the intensified competition and its adverse effect on our results of operations and in order to strengthen our balance sheet. We undertook limitations on our dividend distributions in connection to the issuance of our F through I debentures and other credit facilities. See "Item 8. Financial Information – A. Statements and Other Financial Information - Dividend Policy" and "— B. Liquidity and Capital Resources—Dividend payments" and "- Debt Service" and "- Other Credit Facilities".

 

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Revenues

 

We derive our revenues primarily from the sale of cellular network services (such as airtime and data surfing), handsets and other services, including content and value added services, repair services, and roaming services. Roaming services include roaming charges that we bill to our subscribers for the use of the networks of our roaming partners outside Israel, to which we refer as outbound roaming, and charges that we bill to our roaming partners whose subscribers use our network, to which we refer as inbound roaming. Revenues from airtime are derived from cellular subscribers originating calls on our network and from interconnect revenues from other operators for calls terminating on our network. Since the second quarter of 2012 we also derive our revenues from hosting services.

 

Our revenues also derive from the sale of landline communications services which include: internet connectivity and related services (ISP) and internet infrastructure services (through the landline wholesale market, since February 2015), OTT TV services (since December 2014), transmission services, telephony services consisting of international calling services (ILD) and landline telephony services, operator services and teleconferencing services.

 

Our revenues from cellular services are usually affected by seasonality with the third quarter of the year characterized by higher roaming revenues due to increased incoming and outgoing tourism.

 

Cost of revenues

 

The principal components of our cost of revenues are the purchase of handsets, accessories, equipment and spare parts, interconnection fees, content cost, cell site leasing costs, transmission services cost, internet connectivity services cost, the purchase of call minutes related mainly to international calling services, outbound roaming services fees, salaries and network development and maintenance and cost of Internet infrastructure. Our cost of revenues also includes depreciation of the cost of our network equipment and amortization of our spectrum licenses, rights of use of communications lines. See "-Application of Critical Accounting Policies and Use of Estimates Long-lived assets - depreciation."

 

Selling and marketing expenses

 

Selling and marketing expenses consist primarily of sales force salaries and commissions, advertising, public relations and promotional expenses. We compensate our sales force through salaries and incentives. Our selling and marketing expenses also include depreciation, mainly of leasehold improvements and equipment in our service centers and points of sales, and amortization of intangible assets related to the acquisition of subsidiaries.

 

General and administrative expenses

 

General and administrative expenses consist primarily of salaries and compensation, professional and consultancy fees, leases and maintenance of our offices, bad debt and doubtful accounts allowance, and other administrative expenses. Our general and administrative expenses also include depreciation and maintenance fees, mainly for our billing and information systems.

 

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Other income and expenses

 

Other income and expenses consist primarily of expenses related to employee retirement plan (in 2014, and 2015) and capital gains or losses from sale of property, plant and equipment.

 

Financing income and expenses

 

Financing income and expenses consist primarily of interest expense on long-term loans and interest on our debentures, the interest income component of handset long-term installment sales, the effects of fluctuations in currency exchange rates, Israeli CPI adjustments related to the Israeli CPI-linked debentures and other expenses, and income or losses relating to financial derivative instruments that do not qualify for hedge accounting according to IFRS. Financing income and expenses also include interest income on deposits, premium amortization associated with our debentures, and gains and losses from our current investment in tradable securities.

 

Income Tax

 

Generally, Israeli companies were subject to corporate tax on their taxable income at the rate of 25% for 2013 tax years, 26.5% for the 2014 and 2015 tax years and will be subject to a corporate tax rate of 25% for the 2016 tax year and onward.

 

Israeli companies are subject to capital gains tax at the corporate tax rate. A deferred tax asset or liability is created for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes.

 

Results of Operations - Comparison of 2013, 2014 and 2015

 

The following table sets forth key performance indicators for the periods indicated:

 

   Year Ended December 31,  Change*
   2013  2014  2015  2014 vs. 2013  2015 vs. 2014
Subscribers at end of period(1) (in thousands)    3,092    2,967    2,835    (4%)   (4.4%)
Churn rate of cellular subscribers(1)(2)    36.8%   44%   42%   7.2pp   2pp
Average monthly revenue per subscriber (ARPU) (1)(3) (in NIS)    78    72    65    (7.7%)   (9.7%)
Operating income (in NIS millions)    651    662    310    1.7%   (53.2%)
Net income (in NIS millions)    288    354    97    22.9%   (72.6%)
EBITDA(4) (in NIS millions)    1,335    1,282    872    (4%)   (32.0%)
Operating income margin(5)    13.2%   14.5%   7.4%   1.3pp   (7.1pp)
EBITDA margin(6)    27.1%   28.1%   20.9%   0.9pp   (7.2pp)

 

 
*pp denotes percentage points and this measure of change is calculated by subtracting the 2013 measure from the 2014 measure and the 2015 measure from the 2014 measure, respectively.

 

(1)Cellular subscriber data refers to active subscribers. We use a six-month method of calculating our cellular subscriber base, which means that we deduct subscribers from our subscriber base after six months of no revenue generation and activity on our network by or in relation to the post-paid subscriber, no revenue generating calls or SMS for pre-paid subscriber and no data usage or less than NIS 1 of accumulated revenues from M2M (machine to machine) subscribers. The six-month method is, to the best of our knowledge, consistent with the methodology used by other cellular providers in Israel. In the fourth quarter of 2013 we removed approximately 64,000 subscribers from our subscribers base, following a change to our prepaid subscribers counting mechanism As a result of such change, we add a prepaid subscriber to our subscribers base only upon charging a prepaid card and remove them from our subscribers base after six months of no revenue generating calls or SMS. Following each of these changes, we have not restated prior subscriber data to conform with this change.

 

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(2)Churn rate is defined as the total number of voluntary and involuntary permanent deactivations of cellular subscribers in a given period expressed as a percentage of the number of cellular subscribers at the beginning of such period. Involuntary permanent deactivations relate to cellular subscribers who have failed to pay their arrears for the period of six consecutive months. Voluntary permanent deactivations relate to cellular subscribers who terminated their use of our services. Churn rate data is excluding the above mentioned removals of subscribers.

 

(3)Average monthly revenue per cellular subscriber (ARPU) is calculated by dividing revenues from cellular services for the period by the average number of cellular subscribers during the period and by dividing the result by the number of months in the period. Revenues from inbound roaming services and hosting services are included even though the number of subscribers in the equation does not include the users of those roaming and hosting services. Inbound roaming services and hosting services are included because ARPU is meant to capture all service revenues generated by a cellular network. Revenues from sales of Subscription Repair Services are included because they represent recurring revenues generated by subscribers, but revenues from sales of handsets (which for purposes of this report may include other types of cellular end user equipment, such as tablets), Random Repair Services, and other services are not. We and industry analysts, treat ARPU as a key performance indicator of a cellular operator because it is the closest meaningful measure of the contribution to service revenues made by an average subscriber.

 

We have set out below the calculation of cellular ARPU for each of the periods presented:

 

   Year Ended December 31,
   2013  2014  2015
   (In NIS millions, except number of subscribers and months)
    
Revenues    4,927    4,570    4,180 
less revenues from equipment sales    942    1,005    1,048 
less other revenues*    1,034    941    869 
                
Revenues used in ARPU calculation  (in NIS millions)    2,951    2,624    2,263 
Average number of subscribers    3,135,857    3,034,946    2,898,987 
Months during period    12    12    12 
ARPU (in NIS, per month)    78    72    65 

 

*Other revenues include revenues from other communications services such as ISP, transmission services and local and international landline services.

 

(4)EBITDA is a non-IFRS measure and is defined as income before financing income (expenses), net; other income (expenses), net; (excluding expense related to employee retirement plans) income tax; depreciation and amortization; and share based payments. We present EBITDA as a supplemental performance measure because we believe that it facilitates operating performance comparisons from period to period and company to company by backing out potential differences caused by variations in capital structure (most particularly affecting our interest expense given our significant debt), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age of, and depreciation expenses associated with fixed assets. EBITDA should not be considered in isolation or as a substitute for operating income or other statement of operations or cash flow data prepared in accordance with IFRS as a measure of our profitability or liquidity. EBITDA does not take into account our debt service requirements and other commitments, including capital expenditures, and, accordingly, is not necessarily indicative of amounts that may be available for discretionary uses. In addition, EBITDA, as presented in this annual report, may not be comparable to similarly titled measures reported by other companies due to differences in the way these measures are calculated.

 

The following is a reconciliation of EBITDA with net income and operating income:

 

   Year Ended December 31,
   2013  2014  2015
   (In NIS millions)
Net income    288    354    97 
Financing expenses, net    246    198    177 
Taxes on income    117    110    36 
Operating income    651    662    310 
Other expenses (income), net    (1)   7    (3)
Depreciation and amortization    676    610    562 
Share based payments    9    3    3 
EBITDA    1,335    1,282    872 

  

For a reconciliation of EBITDA with net income by operating segment, see" – EBITDA" below.

  

(5)Operating income margin is defined as operating income as a percentage of total revenues for each of the applicable periods.

 

(6)EBITDA margin is defined as EBITDA as a percentage of total revenues for each of the applicable periods.

 

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The following table sets forth our consolidated statements of income as a percentage of total revenues from operations for the periods indicated:

 

   Year Ended December 31,
   2013  2014  2015
Revenues    100.0%   100.0%   100.0%
Cost of revenues    60.7%   59.7%   66.1%
Gross profit    39.3%   40.3%   33.9%
Selling and marketing expenses    14.6%   14.7%   14.8%
General and administrative expenses    11.5%   10.1%   11.1%
Other (income) expenses, net    -    1.0%   0.5%
Operating income    13.2%   14.5%   7.4%
Financing expenses, net    5.0%   4.3%   4.2%
Income before income tax    8.2%   10.2%   3.2%
Income tax    2.4%   2.4%   0.9%
Net income    5.8%   7.7%   2.3%

 

Revenues

 

   Year Ended December 31,  Change
   2013  2014  2015  2014 vs. 2013  2015 vs. 2014
   (In NIS millions)      

Revenues

   4,927    4,570    4,180    (7.2%)   (8.5%)

 

The decrease in revenues in 2015 is attributed mainly to a 12.1% decrease in service revenues compared with 2014 due to the intensified competition in the cellular market as well as a decrease in ISP and international calling revenues. The decrease in service revenues was partially offset by a 4.3% increase in equipment revenues and revenues from OTT TV services launched in the end of 2014. Netvision's contribution to total revenues for 2015 totaled NIS 809 million (excluding inter-company revenues), compared with NIS 853 million in 2014.

 

The decrease in Netvision's contribution is mainly due to a decrease in revenues from internet services and international calling services and was partially offset by a 63.9% increase in equipment revenues.

 

The decrease in revenues in 2014 is attributed to a 10.5% decrease in service revenues compared with 2013 due to the intensified competition in the cellular market as well as a decrease in ISP and international calling revenues. The decrease was partially offset by a 6.7% increase in equipment revenues. Netvision's contribution to total revenues for 2014 totaled NIS 853 million (excluding inter-company revenues), compared with NIS 933 million in 2013. The decrease in Netvision's contribution to total revenues resulted mainly from a decrease in service revenues.

 

The following table sets forth the breakdown of our revenues for the periods indicated based on the various sources thereof:

 

   2013  2014  2015
   Revenues  % of Total Revenues  Revenues  % of Total Revenues  Revenues  % of Total Revenues
   (NIS in millions)     (NIS in millions)     (NIS in millions)   
Service revenues:                              
Cellular services    2,797    56.8%   2,487    54.4%   2,121    50.7%
Landline communications                              
 services*    1042    21.1%   940    20.6%   866    20.7%

 

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   2013  2014  2015
   Revenues  % of Total Revenues  Revenues  % of Total Revenues  Revenues  % of Total Revenues
                   
Other services**    146    3.0%   138    3.0%   145    3.5%
Total service revenues    3,985    80.9%   3,565    78.0%   3,132    74.9%
Equipment revenues    942    19.1%   1,005    22.0%   1,048    25.1%
Total revenues    4,927    100.0%   4,570    100.0%   4,180    100.0%

 

*Consists mainly of international calling services, landline telephony services, transmission services , hubbing services, internet services (ISP and internet infrastructure services) and TV services.

 

**Consists of repair services fees.

 

During 2015, service revenues (comprising 74.9% of total revenues) decreased 12.1%, compared with 2014. This decrease in service revenues resulted mainly from a 14.7% decrease in revenues from cellular services due to the ongoing price erosion of those services and a decrease in subscriber base resulting from the intensified competition in the cellular market. The decrease in service revenues also resulted from a decrease in revenues from internet services as well as decrease in revenues from international calling services. Netvision's contribution to service revenues totaled NIS 691 million (excluding inter-company revenues) in 2015, as compared to NIS 781 million in 2014.

 

During 2014, service revenues (comprising 78% of total revenues) decreased 10.5%, compared with 2013. This decrease in service revenues resulted mainly from a 11.1% decrease in revenues from cellular services due to the ongoing erosion in the price of cellular services, resulting from the intensified competition in the cellular market. The decrease in service revenues also resulted from a 9.8% decrease in landline communications services revenues such as internet services as well as a decrease in revenues from transmission services. Netvision's contribution to service revenues totaled NIS 781 million (excluding inter-company revenues) in 2014, as compared to NIS 873 million in 2013.

 

During 2015, revenues from landline communications services decreased 7.8% as a result of a decrease in internet services revenues due to price erossion as well as a decrease in international calling services revenues, which were partially offset by revenues from OTT TV services launched at the end of 2014.

 

During 2014, revenues from landline communications services decreased 9.8% as a result of a decrease in internet services mainly due to the erosion in the price of such services, a decrease in international data services and value added services as a result of the intensified competition, as well as a decrease in revenues from international calling services.

 

During 2015, revenues from other services increased 5.1%, compared with 2014. This increase resulted from an increase in repair services.

 

During 2014, revenues from other services decreased 5.5%, compared with 2013. This decrease resulted mainly from a decrease in Subscription Repair Services fees which are characterized by lower revenues but higher profitability in 2014.

 

During 2015, equipment revenues (comprising 25.1% of total revenues) increased 4.3%, compared with 2014. This increase resulted from an approximately 63.9% increase in Netvision's end-user equipment revenues totaled NIS 118 million in 2015, compared to NIS 72 million in 2014.

 

During 2014, equipment revenues (comprising 22% of total revenues) increased 6.7%, compared with 2013. This increase resulted from an approximately 6 % increase in the

 

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number of cellular handsets sold in 2014, as compared with 2013. Netvision's contribution to equipment revenues totaled NIS 72 million in 2014, compared to NIS 60 million in 2013.

 

The following table sets forth the breakdown of our revenues for the periods indicated based on the types of subscribers:

 

   2013  2014  2015
   Revenues  % of Total Revenues  Revenues  % of Total Revenues  Revenues  % of Total Revenues
   (NIS in millions)     (NIS in millions)      (NIS in millions)  
Individual    3,525    71.5%   3,296    72.1%   3,000    71.8%
Business    1,209    24.6%   1,087    23.8%   1,011    24.2%
Other*    193    3.9%   187    4.1%   169    4.0%
Total    4,927    100.0%   4,570    100.0%   4,180    100.0%

 

*Consists of revenues from inbound roaming services, hosting services (since mid-2012) and other services.

 

A breakdown of revenues according to types of subscribers (individual and business) during 2015 compared with 2014, shows a 9.0% decrease in revenues attributable to individual subscribers and a 7.0% decrease in revenues attributable to business subscribers. These decreases resulted mainly from the ongoing erosion in the price of cellular services, resulting from the intensified competition in the cellular market. The decrease in revenues attributable to both individual and business subscribers also resulted from a decrease in revenues from internet services and international calling services which primarily resulted from price erosion due to market competition.

 

A breakdown of revenues according to types of subscribers (individual and business) during 2014 compared with 2013, shows a 6.5% decrease in revenues attributable to individual subscribers and a 10.1% decrease in revenues attributable to business subscribers. These decreases resulted mainly from the ongoing erosion in the price of cellular services, resulting from the intensified competition in the cellular market. The decrease in revenues attributable to both individual and business subscribers also resulted from a decrease in revenues from internet services and international calling services which primarily resulted from price erosion due to market competition.

 

The following table sets forth the breakdown of our revenues for the periods indicated based on the types of subscription plans:

 

   2013  2014  2015
   Revenues  % of Total Revenues  Revenues  % of Total Revenues  Revenues  % of Total Revenues
   (NIS in millions)     (NIS in millions)     (NIS in millions)   
Pre-paid    342    6.9%   317    6.9%   251    6.0%
Post-paid    4,392    89.2%   4,066    89.0%   3,760    90.0%
Other*    193    3.9%   187    4.1%   169    4.0%
Total    4,927    100.0%   4,570    100.0%   4,180    100.0%

 

 
*Consists of revenues from inbound roaming services, hosting services (since mid-2012) and other services.

 

A breakdown of revenues according to types of subscription plans (pre-paid and post-paid) during 2015 compared with 2014, shows a 7.5% decrease in revenues attributable to post-paid subscribers and a 20.8% decrease in revenues attributable to pre-paid subscribers. The decrease in revenues attributable to post-paid subscribers was primarily the result of the ongoing erosion in the price of cellular services, resulting from the intensified competition in the cellular market. This decrease resulted also from a decrease in revenues from internet

 

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services and international calling services. The decrease in revenues attributable to pre-paid subscribers resulted mainly from increased churn of pre-paid cellular subscribers, as well as from the ongoing price erosion.

 

A breakdown of revenues according to types of subscription plans (pre-paid and post-paid) during 2014 compared with 2013, shows a 7.4% decrease in revenues attributable to post-paid subscribers and a 7.3% decrease in revenues attributable to pre-paid subscribers. The decrease in revenues attributable to post-paid subscribers was primarily the result of the ongoing erosion in the price of cellular services, resulting from the intensified competition in the cellular market. This decrease resulted also from a decrease in revenues from internet services and international calling services. The decrease in revenues attributable to pre-paid subscribers resulted mainly from increased churn of pre-paid cellular subscribers, as well as from the ongoing price erosion.

 

Segment Revenues Discussion

 

We operate in two operating segments:

 

Cellcom's revenue segment, which includes Cellcom Israel Ltd. and its subsidiaries, excluding Netvision Ltd. and its subsidiaries, includes revenues from cellular communications services and cellular end user equipment sales, repair services, and OTT TV services (as of December 2014).

 

Netvision's revenue segment, which includes Netvision Ltd. and its subsidiaries. Netvision, includes revenues from internet connectivity services (ISP), internet infrastructure services based on the landline wholesale market (as of February 2015), and additional telephony services such as international calling (ILD), landline telephony and teleconferencing services.

 

We measure revenues on an operating segment basis. The following is a discussion of our revenues for our two operating segments.

 

Cellcom

 

Revenues for Cellcom in 2015 totaled NIS 3,372 million (including inter-segment revenues), compared to revenues of NIS 3,717 million in 2014. The decrease was primarily due to a decline in service revenues of 12.3% due to the ongoing erosion in the price of cellular services resulting from the intensified competition in the market. Equipment revenues in 2015 were similar to 2014.

 

Revenues for Cellcom in 2014 totaled NIS 3,717 million (including inter-segment revenues), compared to revenues of NIS 3,994 million in 2013. The decrease was primarily due to a decline in service revenues of 10.5% due to the ongoing erosion in the price of cellular services resulting from the intensified competition in the market. The decrease was partially offset by a 5.8% increase in equipment revenues primarily due to an approximately 44% increase in the number of cellular handsets sold in 2014, as compared with 2013, and an approximately 6% decrease in the average sale price of cellular handsets, resulted from the increased competition in the cellular handsets market.

 

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Netvision

 

Revenues for Netvision in 2015 totaled NIS 991 million (including inter-segment revenues), compared to revenues of NIS 960 million in 2014. The increase primarily resulted from a 72.7% increase in equipment revenues, which was partially offset by a 2.8% decrease in service revenues mainly resulted from a decrease in revenues from internet services and international calling services.

 

Revenues for Netvision in 2014 totaled NIS 960 million (including inter-segment revenues), compared to revenues of NIS 1,039 million in 2013. The decrease primarily resulted from a 9.8% decrease in service revenues partially offset by 28.3% increase in equipment revenues. The decrease in service revenues mainly resulted from a decrease in revenues from internet services and international calling services, mainly due to price erosion, as well as a decrease in revenues from hubbing services due to a change in the mix of call destinations.

 

Cost of revenues and gross profit

 

   Year Ended December 31,  Change
   2013  2014  2015  2014 vs. 2013  2015 vs. 2014
   (In NIS millions)      
Cost of service revenues    2,271    1,983    2,000    (12.7%)   0.9%
Cost of equipment revenues    719    744    763    3.5%   2.6%
Total cost of revenues    2,990    2,727    2,763    (8.8%)   1.3%
Gross profit    1,937    1,843    1,417    (4.9%)   (23.1%)

 

The increase in cost of service revenues in 2015 compared with 2014 mainly resulted from an increase in content costs related to OTT TV services launched at the end of 2014. 2014 also benefited from a one–time reduction of a provision for cell-sites rent expenses in the amount of NIS 44 million, as well as a one-time cancelation of a provision for communications cables expenses in the amount of NIS 22 million. This increase was partially offset by a decrease in other cost of revenues expenses such as depreciation and maintenance. Netvision's contribution to the cost of service revenues (excluding inter-company expenses) decreased to NIS 450 million in 2015 from NIS 471 million in 2014, mainly due to a decrease in cost of revenues from international calling services and a decrease in communications cables expenses.

 

The decrease in cost of service revenues in 2014 compared with 2013 mainly resulted from a decrease in payroll expenses due to efficiency measures, a decrease in interconnect fees as a result of a decrease in connectivity tariffs, a decrease in cost of revenues from internet and international calling services as a result of a decrease in sales of such services, a one-time reduction of a provision for cell-sites rent expenses in the amount of NIS 44 million, as well as a one-time cancelation of a provision for communications cables expenses in the amount of NIS 22 million. Netvision's contribution to the cost of service revenues (excluding inter-company expenses) decreased to NIS 470 million in 2014 from NIS 602 million in 2013, mainly as a result of a decrease in payroll expenses and interconnect fees, and a decrease in cost of revenues from internet connectivity and international calling services as a result of a decrease in sale of such services.

 

The increase in cost of equipment revenues in 2015 compared with 2014, resulted mainly from an increase in cost of equipment revenues in Netvision to NIS 101 million in

 

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2015 from NIS 55 million in 2014, due to the increase in sales of equipment to business customers, partially offset by a decrease in the average cost of cellular handsets.

 

The increase in cost of equipment revenues in 2014 compared with 2013, resulted mainly from an increase in the cost of cellular handsets, primarily as a result of a 6% increase in the number of cellular handsets sold during 2014 as compared with 2013, partially offset by a 4% decrease in the average cost of cellular handsets. Netvision's contribution to cost of equipment revenues increased to NIS 55 million in 2014 from NIS 47 million in 2013 due to the increase in sales of equipment to business customers.

 

The decrease in gross profit in 2015 compared with 2014, resulted mainly from the ongoing erosion in the price of cellular services and an increase of cost of revenues mainly due to one-time effects during 2014.

 

The decrease in gross profit in 2014 compared with 2013, resulted mainly from the ongoing erosion in the price of cellular services and internet services.

 

Selling and marketing expenses and general and administrative expenses

 

   Year Ended December 31,  Change
   2013  2014  2015  2014 vs. 2013  2015 vs. 2014
   (In NIS millions)      
Selling and marketing expenses    717    672    620    (6.3%)   (7.7%)
General and administrative expenses    570    463    465    (18.8%)   (0.1%)
Total    1,287    1,135    1,085    (11.8%)   (4.4%)

 

The decrease in selling and marketing expenses in 2015 compared with 2014, was primarily the result of efficiency measures we implemented, which led to a decrease in advertising and other expenses and from a decrease in amortization expenses in 2015 compared with 2014 attributable to the acquisition of Netvision. Netvision's contribution to selling and marketing expenses in 2015 totaled NIS 82 million compared to NIS 96 million in 2014.

 

The decrease in selling and marketing expenses in 2014 compared with 2013, was primarily the result of efficiency measures we implemented, which led to a decrease in payroll expenses, advertising and other expenses. The decrease in selling and marketing expenses also resulted from a decrease in amortization expenses in 2014 compared with 2013 attributable to the acquisition of Netvision. Netvision's contribution to selling and marketing expenses in 2014 totaled NIS 96 million compared to NIS 128 million in 2013.