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Partner Communications Company Ltd. (NASDAQ:PTNR)

Q3 2011 Earnings Call

November 23, 2011 10:00 AM ET

Executives

Gideon Koch – Manager, Revenues-Finance Department

Haim Romano – CEO

Ziv Leitman – CFO

Analysts

Michael Klahr – Citibank

Richard Gussow – Deutsche Bank

Darren Shaw – UBS

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Partner Communications Third Quarter 2011 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, November 23, 2011.

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’ results for the third quarter 2011. With me on the call today is Haim Romano, Partner’s CEO; and Ziv Leitman, our CFO.

As a backdrop to our results, our CEO, Haim Romano, is going to first give an overview of Partner’s strategy and Ziv will cover our financial and operational results for the quarter. And finally, we’ll move on to the Q&A.

Before we begin, as a tradition, I would like to draw your attention to the fact that all statements in the conference call may be forward-looking statements within the meaning of Section 27A of the US Securities Act of 1933, as amended; Section 21E of the US Securities and Exchange Act of 1934, as amended; and the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Regarding such oral 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 23, 2011, as well as Partner’s prior filings with the US Securities and Exchange Commission on Forms 20-F, F-1 and 6-K, as well as the S-3 shelf 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. I will now turn the call over to Partner’s CEO, Haim Romano. Haim?

Haim Romano

Thank you, Gideon. Good morning to everyone in US and good afternoon to everyone elsewhere. First, it’s my first conference call. I’m the CEO of Orange in the last six weeks. And it’s a great pleasure to be here again, as you well know, I was one of the founders of the company in ‘98 and left the company in 2005, and now I have the privilege to be here again as the CEO of the company.

What we can see here is continuing of the trend of the first half of the year. The final – the financial results of the third quarter reflect the impact of the regulatory change, including a reduction of the interconnect tariff together with increasing of the competition in the cellular market. These two operational conditions require Partner to prepare and act accordingly while maintaining the company assets and improving operational processes. My first and most pressing task is to refocus on the organizational towards the customers.

Partner has long tradition of treating the customers as one of its main assets. We will continue to take all measures, all necessary steps and action in order to safeguard these key strategic assets. We are implementing now a number of measures aimed to improve the interface of the customer satisfaction and simplicity, and then to increase the customer satisfaction. We expect them to step – improve level of customer service and be well known as the best customer service in Israel as we used to be before. The changes ahead of us are not easy to take, but we are persistent and we’re going to do it the way that we did it before and we are sure that we can do it again.

We also remain focused on long-term needs for the company. As part of these measures, we’re going to intend – we’re going to invest in improving the network and invest in IT systems.

Regarding 012 Smile, we continue to work toward maximizing the synergy between the two companies. At the same time, we are beginning to integrate carefully measure or partner with – or – into Smile. Our vision remains one of which Partner as a group offers the customer wide array of service in areas of cellular and fixed telephony.

Okay. With that said, I would now like to hand the call over to Ziv Leitman, our CFO.

Ziv Leitman

Thank you, Haim. As Haim said, our results continue to reflect the impact of the reduction in interconnect tariff and strengthened competition in the cellular market.

Cellular service revenue decreased by 25% from ILS 1.4 billion in the third quarter of 2010 to ILS 1.1 billion in the third quarter of 2011. This decrease mainly reflects the reduction in interconnect tariff effective January 1, 2011, which reduced cellular service revenue in the quarter by approximately ILS 282 million. Excluding the impact of the reduction in intercompany tariff, service revenue would have decreased by 5%, reflecting ongoing price erosion and ILS 26 million of one-time provision made in the quarter for lawsuits filed against the company.

Compared to the second quarter, service revenue remained steady. However, this reflected the seasonal increase, in particular, from roaming revenues, being offset mainly by the ongoing price erosion and the impact of one-time provision adjusted price. Overall, ARPU was ILS 111 this quarter. This is a decrease of 11% compared with an adjusted ILS 125 in the third quarter of 2010, and a decrease of 1% compared with ILS 112 in the second quarter of 2011.

Operating profit from equipment sales continue to provide an element of support to profitability, boosting profit by ILS 63 million in the quarter, compared with the parallel quarter in 2010. The increase largely reflects an increase in the average revenue per handset mainly due to the proportion of smartphones sold. Compared with the previous quarter, revenues from cellular equipment sales decreased by 25%, the reduction in equipment sales in the second half of 2011 is expected to reduce profits from sales on one hand, but to reduce working capital on the other hand.

Our operating profit for the Cellular segment was ILS 300 million for the third quarter of 2011, a decrease of 37% compared with the third quarter of 2010. This decrease largely reflects the impact of the interconnect tariff reduction on the profit, in the amount of approximately ILS 117 million, as well as the reduction in service revenues.

EBITDA for the segment in the third quarter of 2011 was ILS 447 million, a decrease of 30% year-on-year. The Fixed Line segment, including 012 Smile, provided a contribution to EBITDA of ILS 82 million in the quarter, an increase of ILS 77 million compared with the third quarter 2010, of which 012 Smile contributed ILS 60 million.

Turning to cash flow, the improvement in free cash flow this quarter was mainly due to the decrease in operating working capital in an amount of ILS 132 million. This was an outcome of various factors including: first, a reduction in inventory level of ILS 82 million. Second, an increase in factoring of handsets revenue as a result of higher proportion of sales through credit card transactions as opposed to payment through the customer bill. Third, new arrangement made by 012 Smile with credit card companies to advance the billing cycle payment by number of days, which improved operating cash flow in the quarter by approximately ILS 37 million.

Fourth and finally the reduction in sale of equipment, which I have already described, as a result of these changes, free cash flow increased by 138% in the quarter, compared with previous quarter to reach ILS 376 million.

CapEx in the third quarter was higher than the quarterly level during the first half of the year. This trend is expected to continue in the fourth quarter, reflecting the impact of the upgrade of the company network.

The level of net debt at the end of the third quarter of 2011 stood at ILS 4.72 billion compared with ILS 4.86 billion at the end of the previous quarter. The high level of cash on the company balance sheet is due to be used in part for repayment of Series A Notes in the next two quarters.

Finally, the Board of Director has chosen to distribute dividend for the third quarter of 2011 in the amount of approximately ILS 140 million, representing approximately 80% of the net profit of the third quarter.

That conclude my prepared remarks. Can I now ask the moderator to please begin the Q&A. Moderator?

Question-and-Answer Session

Operator

Thank you (Operator Instructions) The first question is from Michael Klahr of Citibank.

Michael Klahr – Citibank

Hi, everyone. I’ve got three questions. Firstly, on customer service, can you tell us about how you measure that and how you – what you’re doing to change it and improve it? The second question is on 012 Smile. In the – when the company was bought, Partner spoke about ILS 70 million to ILS 80 million of synergies, so I want to understand where you stood on realizing those? And also, there – I think the run rate used to be, when you bought them, in terms of EBITDA, at around ILS 70 million a quarter, so that’s a bit lower, so wanting to understand why that’s lower?

And then my third question is on churn, which has been going higher or trending higher when your competitor’s churn is going lower, so just understanding what the reason for that is and where we can expect churn to go in the coming quarters? Thank you.

Haim Romano

Okay. It’s Haim, CEO. I will refer to the customer service and to the churn rate, and my colleague, Ziv Leitman, will refer to 012. We measure the customer service in the traditional measures of time to – for answering, that is what we call the service level. And our goal is to be around 30 minutes – 30 seconds – sorry, as a standard for 80% of the calls. We measure the one-stop shop calls, one-stop shop calls means that 85% of our calls should be – or problem should be solved in the first call, then other non-measures in the industry. We, last year, recruited more than 3,000 employees to tackle the situation of the market and to be able to answer all the calls regarding the changes in the regulating – in the market.

What we do now is reducing number of agents but increasing the professionality of the agents and the way we work, improving the IT systems and improving the systems. And in that way, we reduce the churn as well and we turn the trend of reducing the level of satisfaction from the side of the customers, and the way that they look at our service is not as good as it used to be before.

Michael Klahr – Citibank

So how long would you expect this process to take – to get to the targets, which you’ve set?

Haim Romano

First, we are not that far from the target in terms of service level. In terms of the other items, we have, I think, three or four months ahead of us to implement the plan. We do it together with reducing quite a big number of agents, being more efficient and being more professional.

I expect the customer service to be as good as it used to be in timeframe of six months from now, not farther than that, we did it before. And as you know, I was the customer manager at the past and I know this company very well, so I’m sure that we can get it in not longer than six months.

Even today, our surveys can prove that our customer service today is better than our competitors or, at least, not bad – not worse than them. So the situation is not that bad that you can – can be perceived from what you read in the papers. We are in a better situation today.

Conferring to the churn rates, I changed, and I think that you could read in the statements, I changed the policy of the company from a market share to retaining our customers and we intend to launch loyalty program, especially for our, what we call score A until D our best customers, and we show that we can find a way to reduce the churn rate, especially for those loyal and heavy payers. It won’t be easy because the market is now in front of penetration of newcomers. But if you take out the pre-paid market from this formula, I think the situation is not that bad and we can be even better if our strategy plan will be implemented the way that we plan to do. Ziv.

Ziv Leitman

Regarding 012, the EBITDA for the quarter was ILS 60 million. But in the quarter, we had changed in the way we do – we capitalize the (inaudible) because of the change in the amendment to the Telecommunications Law, which impose restriction on subscriber exit fines, so this account for roughly ILS 5 million, so ILS 60 million plus ILS 5 million, it’s a run rate of ILS 65 million multiplied by 4. It’s not that far from the ILS 68 million, which is the run rate you remember a year ago.

Regarding the synergies, let’s remember that now we still have structural separation, and only upon the launch of the first MVNO, the structural separation will be lifted. And then, we will see the synergies. A year ago, the company were talking about between ILS 70 million to ILS 80 million synergies coming from expenses as well as from revenues, like cross-sales and so on. And we still think that such a number is achievable. But first of all, the structural separation should be lifted, so we’ll be able to see all these kind of synergies.

Michael Klahr – Citibank

So once the first – to be exact, once the first MVNO comes into the market, launches, you can then start to cross-sell and realize those synergies?

Haim Romano

We expect it to launch in December, this coming December.

Ziv Leitman

And maybe after that, there will be a short period that’s – we need to wait for the MOC regulation.

Haim Romano

It’s formal stage.

Ziv Leitman

Procedure. But it’s shortly.

Michael Klahr – Citibank

Okay.

Ziv Leitman

I guess in the next few months, it will be lifted.

Michael Klahr – Citibank

Okay. Thank you.

Haim Romano

Okay.

Operator

The next question is from Richard Gussow of Deutsche Bank. Please go ahead.

Richard Gussow – Deutsche Bank

Yes. Hi, everyone. I’d like to talk about the decline in equipment sales, Q-on-Q. I noticed that your competitors did not have a similar decline and I was wondering if this is a deliberate strategy on your part to increase cash flow and what can we expect in the quarters going forward?

Ziv Leitman

You’re right. The equipment sales will reduce significantly compared to the second quarter and it’s a combination of a few factors. First of all, the proportion of sales done through credit cards was increased significantly compared to previous quarter, and by that, we improved our cash flow, because once we sell to a credit card, we factor it and then it’s off balance sheet, because it’s a non-recourse transaction. This is one issue.

The second issue, we are not willing to sell the equipment at any price. So we insist of having a certain profitability. This is also a reason why the sales were reduced. And another factor that’s in the first half of the year, there was a big wave of smartphone replacement. So now the phase is much lower, probably in the next few months, once we launch the iPhone 4S and maybe later on iPhone 5, so maybe the level of revenues will be increased, but we need to see what will happen.

Anyhow, we don’t think that’s the rate of – the level of the first half of the year, this is the normal rate.

Haim Romano

I want to add on this with the company for more attention on the quality of the sales in the last quarter, not just (audio gap) and this effort reduce a little bit the number – the real number of equipment that were sold. But the quality of the sale, the number of the churn rate after sale was reducing dramatically.

What I want to mention here that, if you look at the ARPU of our company is much better than the ARPU of our competitors. You mentioned the equipment sale, but you look at the ARPU of our competitors and compare it to ours, the ARPU is still higher significantly than our competitors. And if you look at the network revenue, we have the same level of network, same amount of network revenue like Cellcom, although they have a couple of hundred thousand more subscribers than us – yes, couple of hundred.

So we see that – mainly, the gap between our performance to Cellcom is in the operation expenses. This is the point that we look at it. And those are the efforts that we started immediately after I came to the company, to reduce cost and to improve our operational results, and this is our chance to – in the market.

Richard Gussow – Deutsche Bank

Okay. Also on a different topic, I’d like to ask you about the Hayek Committee and what you see as the potential and risks of the recommendations of the committee?

Haim Romano

We look forward to the Ministry of Communication to adopt the recommendation of the committee and I know that if the minister didn’t decide yet and we met with him and we look forward to the decisions.

Ziv Leitman

And we think it’s a big potential for us once there will be a wholesale market in Israel and once the price will be set according to cost plus rather than retail minus, so it’s a big potential for us.

Haim Romano

Opportunity.

Richard Gussow – Deutsche Bank

Okay. Thank you very much.

Haim Romano

Thank you.

Operator

(Operator Instructions) The next question is from Darren Shaw of UBS. Please go ahead.

Darren Shaw – UBS

Hi, Haim, and good luck on the role. I have two questions. The first one is can you give us your first impressions of being back in Orange, what it’s – how it’s changed over the years since you were last there and maybe comment on its strengths and weaknesses?

And the second question is – actually the net profit in Q3 was actually lower than in Q2, and yet in Q2, the board decided to pay no dividend but in Q3, it’s paying a large dividend, an 80% payout. I just wanted to know if you could comment on the factors behind that decision. I guess it has to do with the free cash flow coming back in which case, Haim, do you suspect there’ll be a change of the official policy of being at least 80% payout ratio linked to net profit and maybe linked more to free cash flow?

Haim Romano

Thank you for your questions. The first one is easy one, so I’ll start with the second one. I think that – I haven’t been here in the second quarter, so I can’t refer on that, but the policy of the company was to look at the results and to –

Ziv Leitman

It’s going be up to (inaudible).

Haim Romano

– distribute 80% of the profit yearly. And I think that the Board of Director decided to stick in that policy and I think that they did the right decision, so for us, it was kind of obvious decision.

Partner is, I would say, it is different than in the past, but it is still a very, very strong, a very promising company. I think that you can find here the foundation of the past. The last year was a dramatically different year from the years before because of the regulation changes, but still the foundation of the company are here. I may see here many of the people from the first days, it’s a very proud company. It’s a very sharp company today, and it would be much more efficient than what I see today and I’m sure that you will see tomorrow.

So in terms of the brand and the way this people inside the company look at the future, they look at very, very optimistically and we feel that we can bring back in slightly short time and – the company to the place it should be, and we will be, again, the leaders of the cellular market in Israel or the telecommunication market in Israel. So we are very optimistic about it.

Darren Shaw – UBS

Thank you.

Operator

There are no further questions at this time. Before I ask Mr. Koch 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 US, please call 1-888-326-9310. In Israel, please call 03-9255-901 and internationally, please call 972-3-9255-901. Mr. Koch, would you like to make your concluding statement?

Gideon Koch

Thank you. This concludes the conference call of Partner’s results for the third quarter 2011. We appreciate your interest and please feel free to contact us if you have any additional questions. Access to this call and to other valuable information on Partner is available through our website at www.orange.co.il. Thank you, and have a very good day.

Operator

Thank you. This concludes the Partner Communications Company Third Quarter 2011 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

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