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Executives

Haim Romano – Chief Executive Officer

Ziv Leitman – Chief Financial Officer

Gideon Koch – Investor Relations

Analysts

Gale Detner (ph) – Bank Leumi

Gilad Alper – Excellence Nessuah

Dov Rosenberg – Klau Finance (ph)

Michael Klar (ph) – Citibank

David Kaplan – Barclays Capital

Partner Communications Company Ltd. (PTNR) Q2 2013 Earnings Conference Call August 28, 2013 10:00 AM ET

Operator

Good morning ladies and gentlemen. Thank you for standing by. Welcome to the Partner Communications Company Second Quarter 2013 Results conference call. All participants are at present in a listen-only mode. For operator assistance during the conference, please press star, zero. Following management’s formal presentation, instructions will be given for the question and answer session. As a reminder, this conference is being recorded August 28, 2013.

I would 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 today on this conference call to discuss Partner Communications Second Quarter Results for 2013. With me on the call today is Haim Romano, Partner’s CEO, and Ziv Leitman, our CFO. Haim Romano will open the call by presenting of the quarterly results and developments. Ziv Leitman will then provide a more detailed explanation of our financial and operational results; and finally, we’ll 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 27(a) of the U.S. Securities Act of 1933, as amended; Section 21(e) 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 August 28, 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 F-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 second quarter 2013 results conference. Our second quarter results continue to reflect the ongoing impact of the competition in the market and the results of the intense efficiency measures taken by the Company in order to lower our costs. At the same time, we continue to invest in infrastructure and improving our customer service.

Our subscriber base declined this quarter by only 11,000 subscribers compared to the previous quarter. Due to the decrease of the prepaid subscriber base, however, our postpaid subscriber increased this quarter for the first time in eight quarters. Our ARPU this quarter totaled NIS 83, a slight increase compared to a NIS 82 in the first quarter for the first time in two years. Our revenue totaled NIS 1.13 billion, a decrease in only 1% compared to the first quarter. This reflects a decrease in our revenue erosion. Our cellular service revenue slightly increased in this quarter compared to the previous one.

OPEX, we managed to decrease by NIS 20 million compared to the previous quarter, and by NIS 153 million compared to the second quarter of 2012. Overall, we have decreased our OPEX by around NIS 600 million on an annual basis.

Our EBITDA this quarter increased by 4% compared to the previous quarter for the first time in the last eight quarters. Net profit totaled NIS 20 million. Despite the improvement of the EBITDA, this is due to the increase of NIS 22 million in finance expenses.

We reported very strong cash flow of NIS 287 million compared to NIS 203 million in the previous quarter. We have reduced our net debt by NIS 176 million compared to the first quarter and by NIS 763 million compared to the second quarter of 2012.

I would like to conclude by saying that we will continue to invest in our advanced network, quality of customer service, and advanced technology, and we will continue to improve and to implement our efficiency measures and to adjust the Company structure in order to successfully cope with the current and future challenges.

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

Ziv Leitman

Thank you, Haim. The financial results of the second quarter reflect the impact of the continuing competition in the telecom market as well as the seasonality effect and the Company’s ongoing efficiency measures. Service revenues for the cellular segment were NIS 726 million, broadly unchanged from the first quarter. This was mainly explained by seasonal roaming revenues which more than offset the continued price erosion in services. The churn rate for the second quarter was 9.4% compared with 10.4% in the first quarter, and the churn rate of postpaid subscribers declined for the third quarter in a row. Equipment revenues in the second quarter of 2013 totaled NIS 180 million, a similar level to the previous quarter. Equipment profitability improved compared to the previous quarter mainly due to increase in subsidy of handsets to large corporate customers, which don’t meet the capitalization criteria according to IAS 38. Service revenues for our fixed line segment were NIS 277 million, a 2% decrease from the previous quarter mainly reflecting the continued strong competition in the market.

In view of the continued price erosion and tough market conditions, the Company continued to adjust its cost structure and implement operational efficiencies which have required a reduction in the workforce by over one third during the last 12 months. As a result of the operational efficiencies, operating expenses in the second quarter of 2013, excluding cost of equipment sold and depreciation expenses, totaled NIS 700 million compared to NIS 720 million in the first quarter. We plan to continue to implement additional operational efficiency measures in the coming quarter in order to reduce operating expenses further.

Mainly reflecting the reduction in operating expenses, the EBITDA for the second quarter of 2013 increased to NIS 280 million compared to NIS 268 million in the first quarter. Financial expenses in the second quarter of 2013 were negatively affected by two factors: first, linkage charges which increased by approximately NIS 15 million due to the higher CPI level; and second, a one-time expense of approximately NIS 9 million due to early repayment of bank loans. In total, net financial expenses increased by NIS 22 million compared to the previous quarter.

Free cash flow after interest continued to demonstrate robustness, totaling NIS 193 million this quarter, largely unchanged from the previous quarter. Free cash flow was positively impacted by improvement of operating cash flow but was partially offset by semi-annual interest payments. As I mentioned, the Company made an early repayment of bank loans in the second quarter in an amount of approximately NIS 490 million, out of which approximately two-thirds relates to 2014 and one-third relates to 2015. Net debt at the end of the second quarter of 2013 amounted to approximately NIS 3.4 billion compared to NIS 4.2 billion at the end of the second quarter of 2012, a decrease of approximately NIS 0.8 billion and a decrease of NIS 1.4 billion from mid-2011.

My last comment is to note the S&P Maalot certification of the Company double-A-minus credit rating and the revision of the outlook from negative to stable, mainly due to the expected leverage reduction in 2014.

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

Question and Answer Session

Operator

Thank you. [Operator instructions]

The first question is from Gale Detner of Bank Leumi. Please go ahead.

Gale Detner – Bank Leumi

Hi, good afternoon everyone. I have a question regarding working capital, which we saw improve in the second quarter by 95 million. Assuming that the top line remains relatively stable at this stage, how much further do you expect working capital to reduce? Thank you.

Ziv Leitman

The positive effect of the working capital is due to the fact that the sales of equipment three years ago were higher than the current level of equipment sales. In addition, currently the level of sell-through credit cards is higher than the level or the percentage of credit cards that were three years ago. I would assume that we can see some positive effect of the cash flow in the next few quarters, but that’s it. For instance, in a year from now, we will not see that positive impact anymore.

Gale Detner – Bank Leumi

Okay, so in terms of what is representative for the business going forward, what kind of level of working capital as a percentage of revenue do you expect is more representative, since at the moment, like you said, the working capital is still carrying the liabilities from the period of high equipment sales in 2011. So what percentage of revenue should it be at? Roughly, you know.

Ziv Leitman

Under the assumption that the current revenues will remain the same, so the level of working capital will remain the same. We will not see further reduction or further increase, in addition to the positive effect that we will see in the next few quarters, but after that it will be stable.

Gale Detner – Bank Leumi

Okay, all right.

Ziv Leitman

This is under the assumption that the equipment level will remain the same.

Haim Romano

This is under the assumption that we want to create the level of selling the equipment, and this is not our intention because we just announced that we have an intention to launch the new division and to increase our sales regarding to equipment. So what Ziv mentioned is due to the fact that this is the current situation; it’s not our plan for the future.

Gale Detner – Bank Leumi

Yeah, okay. Thank you.

Operator

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

Gilad Alper – Excellence Nessuah

Hi, thanks for taking my call. The OPEX in this quarter is down NIS 20 million, and the quarter before that was 24, and then before that 50; so the pace of reduction is coming down, which is natural I guess. But the point is going forward, assuming that the top line isn’t going to increase by much, do you have any other way to expand profits significantly in the future without reigniting this process of cost-cutting? I mean, is there any way for you to re-accelerate cost-cutting to get some profits in the future? Thanks.

Haim Romano

We have some plans. Of course, I can’t emphasize on that, but it’s not the end of the road yet and we will introduce in the future additional cost-cutting, not necessarily on the same areas. But cost of sales, for example, we are looking for a huge reduction in that area and other changes that we intend to do in our operational model. So we will see more operational reduction in some areas that we didn’t touch yet.

Gilad Alper – Excellence Nessuah

If I can just follow up quickly, is there any stage that you might consider – and I think I asked that before – that you might consider adopting the Golan Telecom business model for the private consumers, which basically includes a very thin cost, Internet-based structure with very, very few contact center agents. Are you getting closer to the point of just kind of understanding or believing that this is the way forward, and there’s no other way to get a lot of cost out of the Company?

Haim Romano

No, we have the model similar to the Golan. We use it with Orange too, and very successfully. We put hundreds of subscribers every day to this plan and it has allowed us to reduce the cost of service and the cost of acquisition, of course; but it’s not necessarily good for most of the country, the core of customers. Still, most of the customers are moving from the big guys and between the big guys, not to Golan and Hot. The churn is around those three major operators, so for those that are not sensitive to service and they are more price sensitive, we have the solution of 012 and we are very satisfied with that, even though some were skeptical about this solution; and for those that are willing to pay more and to enjoy the service, we just launched the One Club, and it’s a very successful one. We have more than 40,000 subscribers in this club, and we intend to do more and to add more benefits to this initiative of the One Club.

So on one hand, we’re going to take care of our premium customers, providing them premium service; and on the other hand, we have 012 as the solution for price sensitive or what we call digital customers that are willing to use just the chat or the digital chains of communication.

Gilad Alper – Excellence Nessuah

Okay, thank you very much.

Operator

The next question is from Dov Rosenberg of Klau Finance. Please go ahead.

Dov Rosenberg – Klau Finance

Hi, thank you for taking my call. On the top line, I’m just trying to understand ARPU trends, let’s say going forward. You mentioned that part of the increase in the ARPU was on roaming, which usually has a higher impact in the third quarter. Has that sort of moved over, or let’s say more substantially where do you see ARPU going from here? Have we reached the bottom?

Haim Romano

First, I mentioned that there is a decrease in the erosion of the ARPU and of the revenues of the service revenue overall, mainly in the postpaid but not just in postpaid, so the combination of decrease in the erosion of the ARPU and on top of it the roaming – yes, you are right, the main impact of the roaming is in the third quarter, but we saw some of that in the second one, in the holidays. So the combination of those two, the seasonality and the slight erosion that we are facing now comparing to what we had before, I think we can be more optimistic than we used to be in the past.

Dov Rosenberg – Klau Finance

Okay, and I think you mentioned a few—what measurements you’re taking to improve equipment sales.

Haim Romano

What we decided is to change the organizational structure towards what we call B2C, to being more concentrated on B2C markets and change the model. We’re going to do some changes in our business model regarding the shops and the service centers. It’s too early to declare about it in more details, but the idea is to be more concentrated on the retail chain than on the service chain.

Dov Rosenberg – Klau Finance

Okay. Will that have an impact also on margins, on equipment margins which are very low at the moment?

Haim Romano

The equipment margins will be improved if we will improve our sourcing, and this is another issue that we are tackling now. We have to improve our sourcing, otherwise the margins won’t be that great, and maybe because of the (inaudible) market. So the combination of reducing the cost of sales, doing better sourcing, and improving our distribution channels, go to the digital chains and such.

Dov Rosenberg – Klau Finance

Okay, if can, two more quick ones. The cut in costs this quarter were mostly in the cost of revenues, or all in the cost of revenues. Sales and marketing and G&A, they sort of stayed still or even went up a little bit, excluding the other income. I was wondering if, first of all, you think it’s wrong to look at this on a quarterly basis; and if not, if we should expect further reduction in sales and marketing and pure OPEX.

Ziv Leitman

You should look at it on a yearly basis and not on a quarterly basis. This is why we provide the total number of OPEX, which includes the cost of sales excluding equipment, depreciation and amortization and SG&A together, because there are some one-time items that you see in one quarter and you don’t see in the other. So altogether, you need to relate to the total OPEX, which was 700 million compared to 720 in the previous quarter, and 853 in the second quarter of 2012. Let me just remind you, there’s a number in the third quarter of 2011 before we started the efficiency plan, it was 952 million, which means the total savings on a quarterly basis, it’s 250 million; on a yearly basis, it’s NIS 1 billion, the total savings

Dov Rosenberg – Klau Finance

Okay, thanks. One last question – you guys reduced the debt by almost 180. Are you still standing by your goal to finish the year with 3.3? Is there a different goal, and as part of that – the last of my questions and then I’ll yield the floor – is there any different perspective on dividends going forward?

Ziv Leitman

Definitely we are going to stand behind our intention that the net debt by the end of the year will not be more than NIS 3.3 billion, and you can see that we are very close to this target. Regarding dividends, this is a decision that should be taken by the Board of Directors. Let me remind you that in order to distribute dividends, there are two conditions required by the law, by the corporate law, which is the profit test and maturity test, and of course we meet those two tests; but in addition, the Board of Directors should look at the whole strategy of the Company and the leverage level, so we cannot relate what might be the decision by the Board of Directors regarding this view.

Dov Rosenberg – Klau Finance

Right, okay. Thank you.

Operator

The next question is from Michael Klar of Citibank. Please go ahead. Mr. Klar, are you on the line?

Michael Klar – Citibank

Sorry – yeah, I am. Good afternoon everyone. A few questions. Firstly on the handset sales and the new strategy, do you see a revenue opportunity or is it more defensive? What’s the rationale behind this change from you?

Haim Romano

We see a revenue opportunity in sales of handsets and accessories on one hand and improving the margins in what I mentioned before is improving the sourcing and finding different ways of purchasing and procurement of handsets and improving the logistics chain and all the service chain.

Michael Klar – Citibank

Okay. Is there a cost associated to this, to the new strategy, a material cost or is it just a case of moving existing costs elsewhere?

Haim Romano

No, there will be a cost reduction as well. It will be investment in CAPEX in changing the distribution channels, but the ROI is very short.

Michael Klar – Citibank

Okay, so there will be additional CAPEX associated with that?

Haim Romano

It will be a slight amount of additional CAPEX but very high ROI in a short period of time.

Michael Klar – Citibank

Okay. And when do you expect that to be up and running?

Haim Romano

Actually, we’ve started it. We started changing the look and feel of the shops and the size of the shops – we’ve started shrinking them. You’ll see the full implementation overall in the chain in 10 months up to one year from now.

Michael Klar – Citibank

Okay. All right, thanks. And on the subscribers, you said the postpaid subscribers were flat. Is that correct?

Haim Romano

Slight increase.

Michael Klar – Citibank

Slight increase. Can I ask about 012 Smile? Was there an increase there, or if you break out 012 from that, what does this look like?

Haim Romano

You’re asking about 012 in cellular, or—

Michael Klar – Citibank

In mobile – sorry, yeah, in cellular.

Haim Romano

The increase is in 012 and in Orange as well in the total of the postpaid. The postpaid, we count the postpaid together, 012 and Orange. We don’t differentiate between those two brands when we declare about the postpaid customers.

Michael Klar – Citibank

Okay, so you’re not breaking out where they come from?

Haim Romano

No. We still stay the proportion of recruitment in 012 and Orange segments.

Michael Klar – Citibank

Okay, thanks. And then just about the current selling environment and what you’re seeing on the ground, I know the 12 month offers, at least at your competitors, seem to be coming to an end now, and they say they’re getting some improvements in ARPU from that. Are you seeing the same? What are you seeing at the moment in terms of selling?

Haim Romano

What we see is part of them stayed with their plans, and we see they’re increasing over NIS 14. Some of them, you see some churn, not more than we used to see before; and some of them are looking for cheaper rate plans. So as we declared at last meeting, we have quite good proposal for most of them. They can find a better rate plan if they want to. They can stay in the new additional NIS 14 and then enjoy the One campaign, and some of them unfortunately are looking for different companies and plans, and vice versa with our competitors. But surely this is part of the decrease in the erosion of the ARPU in the market. This is just the beginning of that. At the end of the day, it will be due to the behavior of all the players in the market if they will still introduce special benefits for people that will churn from companies and special campaigns for new customers. We don’t differentiate between our customers and new customers. This is our strategy from Day 1 and we stick with it. But as long as the other competitors are encouraging churn, it’s going to stay a problem.

Michael Klar – Citibank

Right. Am I right – your 1Gb package, your unlimited package, is it still NIS 135?

Haim Romano

NIS 139.

Michael Klar – Citibank

Okay, so you’ve actually—okay, so you’ve actually got a small increase.

Haim Romano

But we have to be genuine and say that we have a lot of promotions anyways, so it’s not—

Michael Klar – Citibank

Okay, but the headline price has gone from 135 to 139.

Haim Romano

It’s not the straightforward market price because we have a lot of promotions, but different from the others, we give these promotions to our customer base as well, so we don’t differentiate. If you go out to the marketplace and come to our company, you’re going to get a discount for several months, similar to what everybody is doing.

Michael Klar – Citibank

Right.

Haim Romano

But we don’t differentiate.

Michael Klar – Citibank

Okay. And then just lastly on the ISP side, you continue to lose subscribers. Obviously there’s very high levels of competition there. What’s going on there? I mean, do you need this wholesale thing to develop very soon? I think you’re losing six—you know, you’re at a negative 6% run rate in subscribers.

Haim Romano

First, there is an improvement now. We see an improvement in that respect, and we hope that the next quarter will be better. Second, when we look forward to seeing the decision—to get the decision of the MOC about the wholesale market, I think the wholesale market will change the picture. We used to suffer. We suffer less than we used to, especially for the aggressive—the offers of Hot and combining cellular and ISP together and offering that at NIS 49 together, actually giving the ISP free in this package. This of course impacts our customer base, not just ours but all the market. We hope that we find a way and find a solution. We do bundles as well, and we will see improvement in our customer base in the future – I’m sure of that. We’ve started seeing that.

Michael Klar – Citibank

Well, what have you done? What are you doing differently to—I mean, that offer is still in the market. We still see Cellcom have an ISP-mobile offer in the market. What have you done—

Haim Romano

So you can see the reduction in revenues in Cellcom as well. If you saw the last quarter results of Cellcom in the ISP, the fixed line, you can see that they are suffering from a reduction in revenues as well. So it’s a very competitive market, and those guys that don’t have infrastructure actually suffer a bit more; but I think that we find a solution. Bundling is one of the ways that we tackle this. We are more regressive in that respect and we feel that we’ll find a way to stop the bleeding in that area.

Michael Klar – Citibank

Okay. And just lastly, what’s your best estimate for a wholesale price in a working wholesale market?

Haim Romano

I don’t know. I hope that it’s going to be very close to our request. We asked for not less than—

Michael Klar – Citibank

No, sorry – I meant timing. What’s your best estimate for timing?

Haim Romano

Timing. The minister said that it’s going to be immediate after the holidays. They didn’t say what holiday.

Michael Klar – Citibank

Okay. All right, thank you very much.

Operator

The next question is from David Kaplan of Barclays Capital. Please go ahead.

David Kaplan – Barclays Capital

Hi. Haim, I think in the last quarter, you guys talked a little bit about how some of the promotions were going to be rolling off in the third and fourth quarter, and if I’m not mistaken it might actually have even been the second quarter. How is that back book rolling off? Is that coming off the way you expected it to? Are customers taking those price increases, or are they coming back to you with—pushing back on you and maybe even switching out to 012?

Haim Romano

Some of them do, some of them don’t; but we don’t see—and remember, we just talked about it in our conference, we don’t see that there is a increase in churn on the country. So for some that are sensitive, we have an alternative and they can find themselves in a better option than the NIS 14 of increasing the rate plan. For the others, they’re staying the new rate plan and enjoying the One Club and the benefits that we introduced to them. Having the One Club is full service and other benefits that we just declared about, and it’s just the beginning of the development of our customer club, the One.

David Kaplan – Barclays Capital

Okay, all right. That’s actually it for me. I’ll see you guys tomorrow.

Operator

If there are any additional questions, please press star, one. If you wish to cancel your request, please press star, two. Please stand by while we poll for more questions.

There are no further questions at this time. Before I ask Mr. Romano to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin in two hours. In the U.S., please call 1-888-782-4291. In Israel, please call 03-925-5921, and internationally please call 972-392-55921.

Mr. Romano, would you like to make your concluding statement?

Haim Romano

I want to thank everybody for joining our Q2 2013 conference call, and have a good day. Thank you very much.

Operator

Thank you. This concludes the Partner Communications Company Second Quarter 2013 Results conference call. Thank you for your participation. You may go ahead and disconnect.

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