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Partner Communications Company (NASDAQ:PTNR)

Q3 2012 Earnings Call

November 21, 2012 10:00 AM ET

Executives

Gideon Koch - IR

Haim Romano - CEO

Ziv Leitman - CFO

Analysts

David Kaplan - Barclays Capital

Gilad Alper - Excellence

Michael Klahr - Citibank

Operator

Welcome to the Partner Communications Company Third Quarter 2012 Results Conference Call. All participants are present in listen-only mode. (Operator Instructions) Following management’s formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded November 21, 2012.

I would now like to turn the call over to Mr Gideon Koch. Mr Koch, you may begin.

Gideon Koch

Thank you, and thank you to all our listeners for joining us on this conference call to discuss Partner Communications results for the first quarter of 2012.

With me on the call today is Haim Romano, Partners’ CEO; and Ziv Leitman, our CFO. We will open the call with Haim Romano who will present the highlights of the quarter together with an overview of partner’s strategic direction. Ziv Leitman, will then provide a more detailed summary of our financial and operational results for the quarter. And finally, we will move on to the Q&A.

Before we begin, I would like to draw your attention to the fact that all statements in this conference call may be forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended; Section 21E of the U.S. Securities and Exchange Act of 1934, as amended; and the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Regarding such forward-looking statements, you should be aware that Partner’s actual results might vary materially from those projected in the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in Partner’s press release dated November 21, 2012; as well as Partner’s prior filings with the U.S. Securities and Exchange Commission on Forms 20-F, F-1 and 6-K, as well as the S-3 self-registration statement, all of which are readily available. Please note that the information in this conference call related to projections or other forward-looking statements is subject to the previous Safe Harbor Statement as of the date of this call.

For your information, this call is being broadcast simultaneously over the internet and can be accessed through our website at www.orange.co.il. If you have any further questions following the call, please feel free to contact our Head of Investor Relations in Israel, Yaffa Cohen-Ifrah on 972-54-909-9039.

I will now turn the call over to Partner’s CEO Haim Romano. Haim?

Haim Romano

Thank you Gideon. Good day everyone and welcome to our third quarter 2012 earnings conference call. I will start my short briefing with overview of the telecommunication market. The solar market is in a traditional period. The third quarter reflects the effect of the changes in Israeli Communication market as well as our measures that we took during the last quarter the last year. Pricing is the key driver in our market to competition today. Generating increases across our industry as price sensitive customers are looking for low cost offers. However, after five months it’s clear now that price is not the only factor driving competition. Most of the customers are still looking for a higher level of service added values and are willing to pay a small premium.

We continue to focus on our strategy to deliver an operational efficiency, network quality and excellent customer service. In respect to the operational side, we have taken measures of efficiency over the last past year which adds to tremendous results and outstanding results which reduce our working force by 2,700 positions over the past year. 850 out of them in the last quarter. Overall we have decreased our OpEx 600 million by 600 million shekels on an annual basis.

In the third quarter we continue to upgrade our network in preparation for 4G technology. We have invested 125 million shekels in the (inaudible) network capacity and speed and on top of it, the IT systems upgrades.

We continue to improve the customer service and the customer relations starting with the clear initiatives, simple and transparent packages. We have succeeded to maintain high level of service while at the same we reduce the cost and personnel. The result of our statutory is best reflected in IR level reported in this quarter, the highest in the market 97 shekels. We are trying to find the balance between maintenance, high ARPU and level of service and in market share.

We choose not to draw in to a price war and maintain a clear policy which does not discriminate between new customers and existing customers, therefore we were able to maintain relatively high ARPU as I mentioned before. At the cost of losing a minor, a small market share.

We launched the O12 model brand digital model targeting price sensitive customers that are satisfied with a digital service which we managed to add tens of thousands of customers to O12 over the past three months.

Turning to the fixed line, we completed the operational with O12 Smile. The merger enhanced our position and is the leading full scale communication group and has increased the value given to our customers. During the quarter we launched a bundled service packages offering cellular, fixed line, ISP services which have been proven as very successful one.

I would like to conclude saying that we are still in position period, we believe that our strategy policy and measures that we took to fight the challenges in the uncertain environment were and still are the right approach.

And now I will like to turn the call over to our CFO Mr Ziv Leitman.

Ziv Leitman

Thank you Haim. The financial results of the third quarter compared to the previous quarter reflect on the one end the impact of

Increasing competition, on the one hand the continued impact of the efficiency measures we have implemented over the past year and seasonality effects. As a result of the fierce competition in the cellular market cellular service rev decreased by 6% this quarter compared to the previous quarter, the decrease mainly reflected the on-going price erosion of cellular service in many of our key services including voice, data and roaming as well as the transition of existing customer to unlimited bandwidth. However, as a result of the significant increase in roaming usage, this quarter, roaming revenues were higher than in the second quarters.

The cellular churn rate rose further this quarter which 10.4% reflecting increased churn in the months of July and August, however, it should be noted that the churn rate for September was lower than that for July and August. Revenues from cellular equipment sales continued to decline this quarter totalling 157 million shekels, a decrease of 50 million shekels from the previous quarter. In line with the second quarter, the main factors that led to the reduction included an increased competition for handset sales and the much quicker payment terms. We expect this new handset models including iPhone 5 may increase revenues in the coming quarters.

Strong competition also continued to effect services revenues from our fixed lined segment including ISP and voice services, but were lesser extent than in the cellular market. Total service revenues for the fixed line segment in the third quarter were 296 million shekels compared with 300 million shekels in the last quarter. However, mainly due to efficiency measures, the EBITDA of the fixed line segment increased to 73 million shekels compared to 56 million shekels in the second quarter.

Turning to expenses, the company continued to implement efficiency measures this quarter including adjusting to work force, to the changing market conditions. In the third

Quarter, the number of workforce position was reduced by around 850 positions. And in total, from September 2011 to the end of October 2012, the number of FTE positions has been reduced by approximately 2,725 positions, most of which was achieved by reducing the level of new recruits. The number of positions at the October 2012 was 5,863.

Operating expenses decreased in the quarter by approximately 60 million shekels reflecting the adjustment of the workforce and other efficiency measures as well as one time decrease in expenses. The company intends to continue implementing operational efficiency measures in the coming quarter in order to adjust the cost structure to the challenging market conditions. As a result of reducing the revenues which was partially offset by the impact of the efficiency measures, EBITDA for the third quarter totalled 401 million shekels, a decrease of 22 million shekels, or 5% from the second quarter. Net profit was 110 million shekels, a decrease of 10 million shekels from the last quarter.

We were particularly pleased with this quarter with the free cash flow results which totalled 310 million shekels after interest payment. As in previous quarter, cash flow was positively affected by decreasing working capital following lower equipment sales and by the high proportion of equipment sales by credit carbon cash. Should this trend continue, working capital will continue to decrease which will positively support the free cash flow in the coming quarters. As most of you already know, in September the board of director results to cancel the existing dividend policy for 2012. Rather the board will assess dividend distribution from time to time depending on development and the company’s cash flow profitability, debt level, debt coverage ratio and business environment in general. The board does not discuss dividend distribution for the third quarter earnings. However, the board will assess dividend for the reporting of the annual 2012 financial results.

Over the last five quarters, the company reduced the level of net debt by approximately 800 million shekels; the company intend to take measure to reduce the level of net debt further by around an additional 800 million shekels by the end of 2013. I will now be happy to open the call to questions. Moderator can you please begin the Q&A?

Question-and-Answer Session

Operator

(Operator Instructions). The first question is from David Kaplan of Barclays Capital. Please go ahead.

David Kaplan - Barclays Capital

Can you give us a little bit of an update of where you are on the wholesale agreements for the Bezeq on the one hand and also even in regards with when exactly that’s going to be signed, what your plans are and what you expect the CapEx is for those projects, I guess that’s my first question.

Haim Romano

We are after the first milestone that we decided with Bezeq. First the agreement with Bezeq has to be divided to three milestones, the first one is to agree on the technical part and we signed the contract with Bezeq, an agreement about the technical part. The second one is to agree about the cost of service that Bezeq will distribute to us and the third part is the cost of the wholesale itself. We decided to give a 30 days of intensive negotiation about the second and third milestone and this is the stage that we are, that we get between our position expectation and regarding to what we think we’d have to get from the wholesale market and Bezeq position, then we have to find a way to close the gap or to go to the ministry of communication to take his decision. We can’t refer today about the CapEx because it will be according to the agreement with Bezeq. So it’s still too early to say if there is a significant amount of CapEx that we have to invest or not or where we go especially we look in the TV market, the IPTV or on the OTT. So it’s early to refer on that.

Operator

The next question is from Gilad Alper of Excellence. Please go ahead.

Gilad Alper - Excellence

Question, the ARPU in Q3 declined by 4 shekels from Q2. Should we expect an even sharper decline in ARPU in Q4 because of the combined effects of competition and seasonality? Thanks.

Haim Romano

Yes, looking at, we estimate the ARPU will decrease further in the first quarter of the result of seasonality effect and continued average price erosion in the market.

Operator

The next question is from Michael Klahr of Citibank. Please go ahead.

Michael Klahr - Citibank

I have got a few questions. First is on the recent price cutting we’ve seen by Pelephone and Cellcom who are now both below 100 shekels. So my first question is, do you see yourself competing at those levels with the partner brand or are you continue to do so with O12 Smile?

Ziv Leitman Haim Romano

I think we gave the answer yesterday by launching a new plan with O12 of 900 watts. O12 will be the answer for that. We don’t have an intention to dilute our brand and to go to a price war. We declared about it before we paid the price of small amount of reduction in our customer base but we believe that enhancing the customer experience and giving them the right approach is the best way to tackle instead of going to a price war. We discussed this a lot of times before and we stick to this strategy.

Michael Klahr - Citibank

And the second question is related I suppose, but you lost 50,000 subscribers in 2Q and similar number in 3Q, is that slowing and is that rate of sub loft flowing in 4Q?

Haim Romano

(Inaudible) about the 4Qs but I can tell you that we don’t count just number of subscribers. You can get in two months the same amount of subscriber or double, it’s just the matter of price. So we look at the combination of number of subscribers. Of course it’s important that our market share is not something that we underestimated but the ARPU is not less important. So we try to balance between the ARPU and the number of subscribers. You know we could go further in the beat of the IDF. It was our decision not to go there. So we could be at the same position as Cellcom but with the ARPU of not 97, an ARPU of 84 or 83 like our competitors. And remember that we don’t have the cushion that Cellcom and Pelephone have from (inaudible). So we have to be more careful about it.

Ziv Leitman

Michael without referring to the first quarter, but in the third, as I mentioned before, the churn rate for September was much lower than the churn rate in July and August. So most of the net loss was in July and August. Q4 there might be other trends, positive or negative but regarding the third quarter, this was the…

Michael Klahr - Citibank

And then just moving on, on margins, obviously you’ve done a lot of work on cost and we’re seeing the results of that, but can you for 2013, can you continue this pace of cost cutting? Can you maintain a 30% margin in 2013?

Haim Romano

The margins are from revenues and from the cost. So I can’t be sure about the revenues but I can assure you that we intend to go along in to the cost cutting and we believe that we are closely to half the way in cost cutting.

Ziv Leitman

Just to be clear, it doesn’t mean that now, you can take the OpEx of the third quarter and cut it by 50%. Just because Haim said this well in the middle of the way. Because I know your models.

Haim Romano

But you have to remember that the run rates today are different from the bond rates of run rates are different from the run rates of the beginning of 2012 of course just in terms of cost of wages, we are around maybe 20 shekels less than we were 25 shekels less than we were in the beginning of last year. So the starting point is much lower than it was at the beginning of 2012.

Michael Klahr - Citibank

So in the quarter if look at OpEx excluding handsets and D&A, I think excluding the one times there was a 30 million shekel reduction in the third quarter, can we continue to see that rate going forward, 30 million shekels or is it going to be tougher than that?

Ziv Leitman

Michael your question is whether the cost will be lower than 820 per quarter? This is the question?

Michael Klahr - Citibank

Yes.

Ziv Leitman

We don’t give guidance for next year but it’s not unlikely to assume that the cost will be lower than 820.

Michael Klahr - Citibank

You talk about net debt being at 800 million shekels lower at the end of 2013. Does that include the dividend?

Ziv Leitman

The guidance or the company intends to reduce the net debt. Of course if the cash flow will be higher, so the company will be able to distribute the dividend.

Michael Klahr - Citibank

Okay, but that’s a target, 800 million shekel reduction by the end of 2013.

Ziv Leitman

Yes, net debt after revenue. Just after everything.

Michael Klahr - Citibank

And then just lastly, on the iPhone announcement, what is that exactly? Is there some sort of exclusivity here or its just sale or purchase agreement.

Ziv Leitman

Framework agreement that it was in the three years ago.

Haim Romano

Unfortunately, iPhone don’t give any to anyone.

Operator

We have a follow-up question from David Kaplan of Barclays Capital. Please go ahead.

David Kaplan - Barclays Capital

Haim you were talking about the fixed line business, I also had asked you about what your potential investment is in that fixed line business, if you could talk a little bit about what that would be? That would be great.

Haim Romano

It’s hard to cover this issue today before we have an idea about the (inaudible). It will be according to the wholesale agreement and then we will know because there is a great variety of options ahead of us. (Inaudible). But we are not sure that it’s going to be significant. If you look at (inaudible) today, we can see something significant that would change the market upside down, but we are willing and ready for the IPTV and we said, we declared in the past that we go there when it was mission feasible, be reasonable and we can make money. Want to invest in something that at the end of the day, we won’t see the ROI effect. This is something I can assure you. It’s not just a strategy issue, it’s an issue of the P&L at the end of the day.

David Kaplan - Barclays Capital

Okay, and then also just on all the mobile market, Michael I guess touched on this to a large extent, but it seems that the deterioration of pricing in the market is not yet over and I guess while partner has made it clear that they are willing to accept a higher churn rate in favour of higher ARPU, to what extent will that remain true? What are the boundaries or what are the borders that partner setting for itself and in terms of pricing and in terms of churn rates before it would lower the headline pricing for its premium brand partner?

Haim Romano

Know that in the end of the day, and quantity can become quality. So of course it’s not something that we can tolerate for long time using our customer base in 500,000 or 600,000 every quarter. So we launched O12 trying to avoid this price war, irrational price war. We actually don’t understand why the majors are doing that but I believe that they know what they are doing that are smart and maybe this strategy is good for them, it’s not good for us. We stick to our strategy to improve our customer service, to improve our customer relationship and experience to improve the network and to give our customers the reason why to stay with us even if they are paying 20 shekels more, it’s not 100% above the market price. Its 20-25 shekels without tricks.

And we believe that we can reach this target to maintain our important customers even if they are paying 20 shekels or 30 shekels more than the lowest rated in the market, but they are paying a little bit more and then dividend is we have to give them much more. And this much more is what we do investing in our network preparing the network for the LTE and the 4G and investing and improving our customer experience. And we see the results. Most of the customers don’t churn. Most of the customers are willing to pay more and they buy the new packages and every day we lose customers but we gain customers from other companies, the options of the customers is to stay at their network paying less, but still, every day thousands or customers are still turning to over network. So it’s more balanced that it seems to be by the numbers because numbers are affected for many reasons.

If you look at our competitor Pelephone, the difference between our strategy and their strategy in terms of ARPU you can see, 97 versus 95 including the cushion that they have from the (inaudible). In terms of net debts, they lost 20,000 and we lost 56,000, 36,000 this is the gap. (inaudible) that is the strategy of 900 shekels in the end of the day is the right strategy that overall of this initiative makes a difference of 36,000 subscribers in the end of the day and our answer to our self is not because we can affect your customer base and we don’t want to discriminate our customers from the customers of the other companies and this is the approach that we don’t adopt.

David Kaplan - Barclays Capital

And just a quick little housekeeping question and then I want to just have one more question if I can on cash flow. When you talk about losing customers, I imagine O12 is also gaining some market share as well. Within partner’s numbers, how is that accounted for? Is that accounted as a sub loss to end gain?

Haim Romano

I think the big advantage of O12 is that O12 and as I said before, we have thousands of customers in O12, but the big advantage of O12 is the low cost maintenance of our customers. There are customers that are willing to get the service in a digital way, they are not very sensitive to service and the average ARPU there is quite good and it’s not like what we see in other companies that are on their basis, they are getting 99 shekels and even below when are doing the win take. We don’t do that.

Ziv Leitman

Your question was regarding whether it’s gross or net?

David Kaplan - Barclays Capital

Yes.

Ziv Leitman

Oh it’s net. When churn is out of partner loop, it’s not out of (inaudible) and coming to O12.

Haim Romano

And the churn includes the prepaid.

David Kaplan - Barclays Capital

If I could just move on, just a quick question on the free cash flow, we’ve seen sequential declines in equipment sales, almost every quarter since the beginning of first quarter of 2011 to the extent that I don’t, it’s not really clear where that number is going to settle out. Where do you see, what is the appropriate amount of equipment sales and clearly that has had a positive impact on free cash flow and so I am just trying to, in terms of thinking forward, or thinking ahead, where is the right amount of equipment sales per quarter on a sustainable basis so that I can kind of mallow out my cash flow going forward and changes in working capital?

Haim Romano

Unfortunately we cannot disclose the budget number but I can tell you the following, we will not see the numbers of 2011. On the other end, I don’t think that the sales total numbers of 157 million shekels that this number really represent the future sales.

David Kaplan - Barclays Capital

Is there new equipment coming into the market? Are you expected to give a boost or was it just a onetime effect of something in the third quarter that caused large 157 type numbers.

Ziv Leitman

I think in 2013, we will see more sales of handsets from all the three major companies, the iPhone 5 and the Microsoft Windows 8, and the Galaxy 4 and others will do some changes in the market and people are willing to buy now to renew their handsets to more than smartphones.

David Kaplan - Barclays Capital

So is that to say that buying essentially and the holding pattern right now just waiting for the new equipment to come out?

Ziv Leitman

Yes, but if you want to refer to the cash flow, we protect our self by conducting a policy that obligates…

Haim Romano

There is much more big payments there which means more sales are done via credit cards rather than by the monthly invoice.

Ziv Leitman

We are (inaudible).

Operator

(Operator Instructions) There are no further questions at this time. Before I ask Mr Romono to go ahead with his closing statements, I will like to remind participants that a replay of this call is scheduled to begin in two hours. In the US, please call 1888-782-4291, in Israeli, please call 03-925-5904 and internationally, please call 972-3925-5904. Please Romano would you like to make a concluding statement?

Haim Romano

No, I just want to thank everybody for joining the third quarter 2012 conference call. Have a nice day.

Operator

Thank you. This concludes the Partner Communications Company third quarter 2012 Results conference call. Thank you for your participation, you may go ahead and disconnect.

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