Chairman’s Letter to Shareholders

Dear Shareholders,

As you are all aware, the general circumstances of the country have gone from bad to worse. The security situation, financial siege, the inordinately long period of strikes of public sector employees, as well as the general atmosphere of war, strife and uncertainty could not but impact negatively on the overall business environment. The purchasing power of Palestinian consumers was severely eroded from a base that was depleted in the first place due to the cumulative effect of years of siege and repression. Simple business operations that are taken for granted in other countries have become very difficult. Physical movement of goods and personnel from one place to another has become a severe constraint as has the ability to import raw materials through Israeli ports (the only access to the outside world for goods and raw materials).

This has forced Jerusalem Cigarette Company Ltd to adopt certain measures that it would not have done otherwise. First among these is to increase its holdings of raw materials, especially raw tobacco. The value of the latter has increased from 18 million Shekels at the end of 2005 to 31 million at the end of 2006. Secondly, because of the extended strike of the employees of the Palestinian Authority, and the fear that this strike might recur at any time, JCC had to buy from the Palestinian Customs & Excise Department (against post dated cheques) additional quantities of banderole stamps that were over and above its immediate needs. The decision to build up these “reserves” of raw material and banderole stamps have naturally placed a considerable strain on JCC’s finances. This explains the delay in the actual date of payment to JCC’s shareholders of the dividends authorized by the previous AGM covering the year 2005.

Nevertheless, the year 2006 has not been all gloom and doom for JCC. We are pleased to report a number of positive developments. First, JCC has managed not only to maintain its sales, but to increase them over the previous by 12% in value terms. At the same time JCC kept its administrative and production costs at or near the level of previous years, resulting in a significant rise in net profit from approximately NIS 9.3 million in 2005 to approximately NIS 16.5 million in 2006. The rise in sales has obviously resulted in increased payments to the Palestinian Authority, reaching the level of approximately NIS 235 million in excise duty on goods actually sold to retailers and wholesalers (and considerably more in duty on cigarettes produced but not yet sold by the end of 2006).

Second, the close co-ordination between the Palestinian Department of Customs & Excise (part of the Ministry of Finance) and JCC to combat the pervasive smuggling of cigarettes has succeeded in drastically limiting this smuggling, but not, unfortunately, eliminating it altogether. This appreciable, but incomplete, success has certainly been to the benefit of the Palestinian Authority and the legitimate importers and producers of cigarettes in Palestine.

Third, JCC has embarked on a strategy of diversification away from tobacco products into the importation and marketing of non-tobacco products. In this strategy, JCC will benefit from its experience and capabilities in the field of direct sales of cigarettes which it has built up over the past seven years. The synergy in terms of economies of scale, shared expertise, shared personnel, familiarity with markets and market participants will be of considerable benefit to both divisions of JCC, tobacco and non-tobacco. In pursuit of this, as well as being a part of its long-term strategy of investment in real estate, JCC has purchased land adjacent to its current site (c 1,100 square meters) at a cost of NIS 2.32 million. This land has enabled JCC, for the first time, to have a direct frontage on the main street of Azariyeh. In addition, JCC is now constructing storage and distribution facilities on its site in order to facilitate this diversification strategy.