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Partner Communications Company Ltd. (NASDAQ:PTNR)

Q1 2013 Earnings Conference Call

May 22, 2013 10:00 AM ET

Executives

Gideon Koch - IR

Haim Romano - CEO

Ziv Leitman - CFO

Analysts

David Kaplan - Barclays Capital

Gilad Alper - Excellence Nessuah Investment

Michael Carr - Citibank

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Partner Communications Company First Quarter 2013 Results Conference Call. All participants are at present in a 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 May 22nd, 2013.

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

Gideon Koch

Thank you, and thank you to all our listeners for joining us on this conference call to discuss Partner Communications first quarter results for 2013. With me on the call today is Haim Romano, Partners' CEO; and Ziv Leitman, our CFO. Haim Romano will open the call by presenting the operational and financial highlights of the quarter. Then Ziv Leitman will present a more detailed summary of our quarterly results; 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 May the 22nd, 2013; 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 shelf-registration statements, all of which are readily available. Please note, 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

Good day everyone, and welcome to our first quarter 2013 results conference call. Our first quarter results reflect the continuing impact of the competition, as a result of the price erosion in the market and led to the decline of our revenues and profits. Despite the decline in our revenues and profits, the company continued its trend to invest in our assets.

Our investment in the first quarter was approximately NIS130 million mainly in the cellular network and development of the technology and advanced infrastructure. During the quarter, we launched Orange ultranet, the most advanced and fastest cellular network in Israel. At the same time, we continued our efficiency measures, which led to a decrease of NIS152 million in the OpEx, excluding equipment compared to the first quarter of 2012 and the decrease of NIS600 million and in annual returns. The company reported quarterly strong free cash flow of NIS203 million. Having said that, we have reduced the net debt by approximately NIS190 million compared to year 2012.

In this quarter, we have witnessed a decline in our churn rate. Our Post-Paid subscriber base, has remained at similar level as it was in the fourth quarter of 2012. The decline in the company's subscriber base is a result of a decline in the Pre-Paid subscriber base, reflecting the seasonal changes and the continued trend of customers shifting from Pre-Paid to Post-Paid packages.

I would like to conclude my brief, saying that we will continue to implement efficiency measures in adjusting the company structure through the changes in the market conditions. In order to successfully cope with the current and future challenges. We will continue to invest in the company assets in our natural quality customer service and advanced technology.

Now I would like to turn the call to our CFO, Mr. Ziv Leitman.

Ziv Leitman

Thank you, Haim. The financial results of the first quarter of 2013, compared to the previous quarter reflects, on one end, the continued revenue erosion resulting from the fiercely competitive market condition, and on the other end, the continued impact of efficiency measures the company implemented over the course of the quarter, partially offset the revenue decrease.

Sales revenue of the cellular segment were NIS724 million, an 8% decrease from the previous quarter. The decrease was mainly explained by the continued price erosion in services, including voice, data and roaming, and the transition of customer to unlimited packages. As a result of the above, ARPU decreased to NIS82 in the first quarter of 2013, compared with NIS87 in the previous quarter.

The churn rate in the first quarter of 2013 was 10.4%, an improvement on 10.9% in the previous quarter, as a result of the reduction in the Post-Paid churn rate, which was partially offset by an increase in the Pre-Paid churn rate. The company's cellular subscriber base at the end of the first quarter of 2013, totaled 2.93 million, with our Post-Paid subscriber base remaining stable, whilst our Pre-Paid subscriber base continues to decline.

Equipment revenue in the first quarter of 2013 decreased to NIS183 million from NIS222 million in the previous quarter, mainly reflecting the decline in the number of handsets sold. The gross profit from equipment was also negatively affected by the sale of subsidized handsets, to large corporate customers, which didn't meet the capitalization criteria according to IAS 38.

Service revenues from our fixed line segment, including ISP and voice services were NIS283 million, decreasing by 4% from the previous quarter, reflecting the continued strong competition in the market. In order to mitigate the impact on profits, of the decline in revenue, the company continued with the efficiency measures, which we began 18 months ago. In particular, we have continued to adjust the level of work force to the changing market condition, and the size of the work force to 4,772 on an FTE basis by the end of March 2013.

As a result of the decrease in the work force and other efficiency measures taken, operating expenses decreased by approximately NIS24 million compared to the fourth quarter of 2012. The company will continue to implement additional operational efficiency measures in the coming quarter, in order to further reduce operating expenses.

The outcome of the above effect was that EBITDA for the first quarter of 2013, amounted to NIS268 million compared to NIS340 million in the fourth quarter of 2012. Financial expenses in the first quarter of 2013, increased by approximately NIS11 million, mainly due to increased linkage charges, as a result of a greater increase in the CPI index, compared to the previous quarter. In consequence, net profit totaled NIS31 million in the first quarter compared with NIS102 million in the previous quarter.

Free cash flow after interest remained robust this quarter, totaling NIS192 million. Following the trend of the last few quarters, cash flow was positively affected, by decrease in working capital.

Finally, the company continued to lower net debt. Over the last 12 months, our net debt has been reduced by approximately NIS800 million in total, and stood at NIS3.6 billion at the end of the first quarter.

I will now be happy to open the call to questions. Moderator, can you please begin the Q&A?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. The first question is from David Kaplan of Barclays Capital. Please go ahead.

David Kaplan - Barclays Capital

Hi everyone. I actually have a whole bunch of questions, so feel free to stop me, I can get back online if you like. The first one has to do with the gross profit from equipment sales for cellular. You talked about a little bit now, you said in your prepared remarks about the capitalization. Can you quantify for us what that number was, what you normally would have capitalized, and is that something you expect to continue on this year, given the competition in the market, or do you expect to be able to capitalize some of those costs in Q2?

Ziv Leitman

We didn't disclose the number of -- the amount of subsidy with the handset. Therefore we cannot disclose it now. But we don't expect this trend to follow in the future.

David Kaplan - Barclays Capital

Okay. The second question also, I mean, clearly the company has been reducing its overall leverage, but if you look at the leverage ratios, because of the declining EBITDA was so drastic, I guess because of the capitalization in this particular quarter. Hence I guess, a related question, where now net debt-to-EBITDA seems to be well over 3, is there something the company is going to plan to do to manage that, or again, does it just have to do with the timing, given the capitalization question I asked earlier?

Ziv Leitman

David, as you will recall, at the end of the third quarter 2012, the company said, it is our intention that by the end of 2013, the net debt will be not more than NIS3.3 billion. Now, when you [underline] [ph] debt-to-EBITDA ratio, in my opinion, you shouldn't take one quarter, you should take a much longer period, let's say one year. So if you take the last four quarter, it's a total different ratio, rather than taking just the last quarter.

David Kaplan - Barclays Capital

Right. I agree with that, I just think that the -- at a point in time also, it does jump out and I don't know how much of it is cosmetic, because of the capitalization question, or how much of it is something that we need to keep our eye on?

Ziv Leitman

These are the reported results. We don't change the reported results. But I don't think the right way to calculate the debt-to-EBITDA according to one quarter.

David Kaplan - Barclays Capital

Okay. Third question about seasonality in the business. With the price erosion we have seen over the last couple of years, was once upon in time, normal seasonality, has kind of disappeared from the results. Is that continued erosion something you consider -- or would expect to see for the rest of 2013, or do you think we might see some semblance of seasonality come back during this year?

Haim Romano

Seasonality is part of the business, especially in the roaming segment. So you can expect seasonality and still expect seasonality. It's true that the main customer base is in unlimited. But still we can expect the effect of seasonality. Actually, you saw it in the first quarter -- the first quarter traditionally is a slower one.

David Kaplan - Barclays Capital

Right. The third quarter is generally a strong one, if you look back over the last two years, they have been sequentially down, both 3Q 2011 and 3Q 2012 and I am wondering in 2013, we should expect the same as we have seen over the last two years, or is the market kind of coming down, and because there are so many people on unlimited, with roaming revenues expected to increase in the third quarter, given normal seasonality, should the third quarter again, be or the second half I guess, be a stronger half relative to the first, in 2013?

Haim Romano

The roaming is a still relevant item to be expected. I can't refer to the either issues, but the roaming will be a thing, still a relevant item.

David Kaplan - Barclays Capital

Okay great. I am getting to the end, your answers are actually pretty quick. On inventories, you said the build in inventory had to do again with competition in the market. Was any of that specifically related to the iPhone 5 launch, was there a buildup of inventory of iPhones that you expect to kind of work your way through in Q2?

Haim Romano

Yes, the iPhones and the iPads as well. But we have some plan to reduce it in any way.

David Kaplan - Barclays Capital

Great. And then the last one, just a normalized tax rate, I know there is a onetime that kind of caused this quarter to be high, or you expect to come back closer to the 25% range over the rest of the year?

Ziv Leitman

Usually, part of the expenses are not recognized by the tax authorities. But this amount is in shekel terms, it's not percentage wise. So when the profit before tax is, let's say for example, is NIS150 million, but percentage wise is rather small, while the profit before tax, is let's say, NIS50 million, the percentage is much higher for the same amount of shekels. So you cannot expect the tax rate to be exactly according to the corporate rate, which is 25%. Always, it was higher.

David Kaplan - Barclays Capital

Not always, like the first quarter or the fourth quarter last year, but when we think about a normalized tax rate, is 25% the right number to use?

Ziv Leitman

On a yearly basis, it's always higher than 25 and you shouldn't expect that it will be 25.

David Kaplan - Barclays Capital

Great. Thank you.

Operator

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

Gilad Alper - Excellence Nessuah Investment

Hi. Thanks for taking my call. Just from the headcount, the headcount in Q1 is down by 600 employees. Should we expect a similar rate of decline in headcount over the next few quarters, and at what stage do you reach to a point, where you need to change completely, the way Partner does business? I mean, do you need to at some stage, give up, may be service for private consumers, and I mean, does that happen when you reach 4,000 employees, 3,500? How should we think about that? Thanks.

Ziv Leitman

Wow, it's a very tough question.

Gilad Alper - Excellence Nessuah Investment

Very tough market.

Haim Romano

Yeah. We reduced something like -- almost 700 positions, and it wasn't reflected fully in the quarterly results, because it was spread over the quarter, you will see it in the next quarter of course. But it's hard to tell, of course that the market is changing and the way of getting service is changing, and we are adjusting ourselves, and I don't have the time to [talk] [ph] the situation that I can describe. The vision of the company, regarding the next generation service, but no doubt, it's going to be a different ball game.

Gilad Alper - Excellence Nessuah Investment

Okay. I mean, my follow-up I guess --

Haim Romano

Small digital wholesale service. It's not just the services, but it’s the salesforce and the way you do business with corporates, the whole model is changing, and we are not waiting, we are doing everything we can to face the future.

Gilad Alper - Excellence Nessuah Investment

Okay. I mean, my follow-up is kind of related to that, I guess is, I mean, basically, do you guys see any signs of stabilization? I mean, the churn is slightly down, do you see maybe two newcomers having a bit of a smaller impact on the market. any reason for optimism?

Haim Romano

You know the difference between optimism and pessimism?

Gilad Alper - Excellence Nessuah Investment

No.

Haim Romano

Pessimist is someone that used to be an optimist before.

Gilad Alper - Excellence Nessuah Investment

Okay.

Haim Romano

So we used to be optimist about the new players in the market, and we better review when we speak, and we prepare ourselves to the current situation. The reduction of the amount of turnover in the market, and you see that our [thought] is lower than it used to be, and actually as I mentioned and Ziv said before, in our customer base, the Post-Paid is quite stable, and less subscribers are leaving us, and of course, we service, but this is a good news. So we see kind of stability in the customer base in the Post-Paid and the reduction of the turnover. I hope that this is a good sign we see. But we have some experience from the past, so I don't want to be too optimistic about it. I hope that this atmosphere will be sustainable in the market. But with the reduction of the intensive (inaudible).

Gilad Alper - Excellence Nessuah Investment

Okay. Thank you.

Operator

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

Michael Carr - Citibank

Hi. I have got three questions. Firstly, can you tell us a bit about the 012 Smile business, and I mean, in the mobile, the sub-brand, and some indication in terms of numbers of subs? Is it tens of thousands, hundreds of thousands, and also what type of subs are there? Are they -- what the share of those subs would be, ex-Orange?

Haim Romano

It's a very tough question, because we don't disclaim our -- I will try to tell you. First, we almost ended the merger between 012 and Partner operations (inaudible), and this is something very important, that allowed us to reduce the costs, for both companies. 012 mobile, we are very satisfied with the results of 012 mobile. And I can't tell you the exact numbers, significant numbers not hundreds of thousands, but more than maybe the market expected. It's a very efficient business because they pay less, but there are low cost customers in all means.

The demand of service there is very low, and it's a very efficient business. It allowed us to maintain our customer base, without dragging down all our Orange customers, up ARPU wise. Most of the customers are not Orange customers, and this is the maximum that I can --

Michael Carr - Citibank

Okay. That's very helpful. My second question is on the efficiency measures going forward. Can you give us some concrete examples of measures not yet introduced or not fully in the numbers, apart from just talking about broad headcount numbers, but rather initiatives, what's left to do or what you can continue to do?

Haim Romano

There are many initiatives that you can't see or you couldn't see in the last quarter, like in the assets for example that reduced the amount of taxes, the amount of meters that we rent, and other issues. But unfortunately, I can't elaborate on that. But there are.

Michael Carr - Citibank

Okay. And then, on the fixed business, as you have added some fixed lines, but the ISP subs have been falling, I just wanted to understand those dynamics a bit better, what the -- is that part of the strategy, or is it due to heavy competition, and what's actually going on in that business?

Haim Romano

Compared to last year, the main problem was the penetration of HOT-NET, and we see that we manage to overcome this in the last quarter. As a result they are better than they used to be, but still we have some adjustments to do, and we are working on that. We are not too satisfied from the result of the ISP business, and we have some work to do, and we are working on that.

Michael Carr - Citibank

Okay. My last question is again on the inventory. The handset sales are coming down, and you have the big boom with iPhone or the introduction of iPhone in Q4. So I don't quite understand why inventory is going higher?

Haim Romano

First, the iPhones started in Q4, but they were actually introduced in the end of Q4, but most of the sales were in the first quarter, and on top of it came the iPad inventory. But Ziv, if you want to elaborate on that?

Ziv Leitman

As you will recall, in the fourth quarter, there was a shortage of shipment from Apple. So particularly, it was a situation almost like a stock-out, which is normal, if you don't have stock in the shops, or in the channel, and most of the shipment arrived in the third quarter.

Michael Carr - Citibank

So did the shipment kind of arrive too late off the -- would you say that demand for the iPhone 5 is perhaps a bit less than you had anticipated?

Haim Romano

It started very strong and it slowed down, but we don't suffer from huge inventory in iPhone. It's not a slowdown of the demand, it made the inventory coming up to that. The exception was Q4, with shortage of the inventory, and the shortage will be in the middle of that. We won't see the same amount of inventory, I believe, but we want this to come back to 90 million, because it was a very short inventory at that time.

Michael Carr - Citibank

And you will be able to do that without the impact on the gross margin and on the equipment side? So without the hit that you took in the first quarter, or the subsidies --

Haim Romano

It's not related.

Ziv Leitman

There is no connection between the level of inventory, and selling subsidized handsets to large customers.

Haim Romano

It was a onetime hit, it's not the --

Michael Carr - Citibank

Okay. Thank you.

Operator

[Operator Instructions]. There are no further questions at this time. Before I ask Mr. Romano to go ahead with his closing statements, I am going to remind participants, that a replay of this call is scheduled to begin in two hours. In the U.S., please call 1888-326-9310. In Israel, please call 03-9255-904 and internationally, please call 9723-9255-904. Mr. Romano would you like to make your concluding statement?

Haim Romano

Thank you, everyone. I want to thank you for joining our Q1 2013 conference call. Have a good day.

Operator

Thank you. This concludes the Partner Communications Company first quarter 2013 results conference call. Thank you for your participation. You may go ahead and disconnect.

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