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Partner Communication Company, Ltd. (NASDAQ:PTNR)

Q2 2012 Earnings Call

August 14, 2012, 11:00 a.m. ET

Executives

Gideon Koch – Manager, Revenues Finance Department

Haim Romano – CEO

Ziv Leitman - CFO

Analysts

David Kaplan – Barclays Capital

Simon Morris – Citibank

Gilad Alper – Excellence Nessuah Investment House

Operator

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 second quarter 2012. With me on the call today is Haim Romano, Partner’s CEO, and Ziv Leitman, our CFO. Haim Romano will be opening the call by sharing some thoughts on recent developments in the market and Partner’s strategic direction. Ziv will then discuss our financial and operational results for the quarter, and finally we’ll move on to the Q&As.

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 Exchange Act of 1934, as amended, and the Safe Harbor provisions of the U.S. 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 August 14th, 2012, as well as Partner’s prior filings with the U.S. Securities and Exchange Commission on forms 20-F1 and 6-K, as well as the S-3 shelf registration statements, 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, [inaudible] at 972-54-909-9039. I will now turn the call over to Partner’s CEO, Haim Romano. Haim?

Haim Romano

Thank you, Gideon. Good morning, good afternoon, ladies and gentlemen, please allow me to welcome you to our second quarterly 2012 conference call. I will start my short briefing with a review of the recent events in the telecommunication market in Israel.

Firstly, I will describe the competition in the cellular market, and say that during May, last May, two new cellular operations launched, Hot Mobile and Golan Telecom. The new operators offer to the customer an unlimited plan at an aggressive price of NIS 98 and NIS 99. The launch was heavily promoted by PR campaigns, supported by the Israeli media and the Ministry of Communication. Existing cellular companies responded also by launching an unlimited package. The statistical approach of telephone was trying to maintain the market share almost at any price, offering an unlimited plan at the price of NIS 99. Cell com offering bundles of services [inaudible] aggressive offers to the business customers determined to maintain their customers almost at any price.

Our strategy was maintaining ARPU even at the price of [inaudible], offering unlimited plans at the price of 125 and NIS 135, the highest plan in the market, and launching 012 mobile sub-frames for customers who are only sensitive to the price but not to service and they are willing to stay with the service that is best on the internet. The outcome of our strategy, we managed to maintain the [inaudible] at NIS 101, the same as at Q1. As for the MVNOs, there is no doubt that the MVNOs are the main losers for the entry of the new operators. Currently, they’re also offering unlimited plans.

Moving to the fixed line markets, we face increasing competition in the ISP markets. The competition in the [inaudible] launch caused a decline of our market share from 33 to 32. The rate of the market share’s decline slowed down towards the end of the quarter. In the last quarter, we accelerated full operation merger with 012, and we started offering to our customers a telecommunication bundle service, fixed line and mobile. In spite of the operational efficiency in Q2 2012, op ex increased by NIS 100 million compared with Q3 2011. We managed to reduce 2,100 positions from October, 2011 until July, 2012, and it is not the end of our efficiency plan. On an annual base, we managed to save something like NIS 250 million annually.

For the technology progress, we are continuing the network operating, optimizing and enhancing the network towards the (NYSE:LG). Currently, 70% of our network was upgraded to LG-ready. In addition to that, and to respect with the IT systems, the board of directors approved investment of NIS 60 million for our next generation of the CRM version of [inaudible].

In respect with the TV, we continue with our operation to launch a television service Over the Top, OTT. Once the condition will be matured, in the end of the day, to the end of the Minister of Communication, to solve the problem of our relationship with Bezeq and Hot, and it’s in, as I said before, it’s in the hands of the Minister of Communication. After that, we’ll be able to introduce to the market innovative and attractive solutions.

Wholesale market, we are in the middle of negotiations with Bezeq. There is not really a genuine negotiation. We talked about the wholesale market, and the same as with TV, it’s at the end of the day, we think that without the [inaudible] of the Ministry of Communication, we won’t see significant progress with the wholesale market.

In closing, we are continue to focus our assets, our valued customers and employees in Orange brand. I would like to hand over the call to Mr. Ziv Leitman. Thank you, Ziv.

Ziv Leitman

Thank you, Heim. In view of the big changes in the cellular market over the past year, I will focus my remarks on the results of the second quarter compared with those of the first quarter of 2012. This quarter, revenue declined, mainly due to a sharp drop in the quantity of cellular equipment sold, which led to a decrease in equipment revenue of NIS 150 million. The main factors that led to the reduction included fierce competition for handset sales, increasingly strict customer payment terms, a general decrease in market demand and to the use of special rebates for customers who purchased new handsets.

Service revenues for the cellular segment decreased by NIS 40 million in the second quarter of 2012 compared with the first quarter, but this also includes seasonal effects. ARPU remained unchanged at NIS 101.

Churn continued its upward trend, reflecting both the impact of the aggressive pricing strategies of the new entrants and the company’s policy not to discriminate between existing customers and new customers. However, given that the new operators entered the market during May, the outgoing churn rate for the second quarter of 2012 do not reflect the full impact of the increased competition.

Service revenues for the fixed line segment decreased by NIS 20 million, or 6%. This reflected the impact of the increased competition on the subscriber base and price level, mainly in the ISP and local fixed line markets. In addition, revenues for the fixed line segment were reduced in the quarter by NIS 8 million due to the change in intersegment charging for transmission services. The cellular segment’s expenses were reduced by the same NIS 8 million, so there was no effect on the consolidated results.

Group operating expenses decreased in the quarter by approximately NIS 90 million, mainly reflecting the continued focus on efficiency measures and our [inaudible] control of the cost structures. Our new agreement for transmission services with Bezeq contributed approximately NIS 10 million to the reduction in expenses, but on the other end, there was one-time expenses in a similar amount related to reduction in workforce.

Total EBITDA for the second quarter was NIS 423 million, a decrease of NIS 50 million compared with the first quarter, which is a result of the service revenue reduction in the cellular and fixed line segments, together with equipment sales reduction, partially offset by savings in costs.

Net profit was NIS 120 million, compared with NIS 146 million in the first quarter, a decrease of NIS 26 million. As well as the factors I’ve just described, the decrease in the net profit also reflected higher financial expenses due to the increased link in expenses from the increase in the CPI index level of 1.2% this quarter, compared with no change in the previous quarter.

Free cash flow, after interest payments, was relatively strong this quarter, totaling NIS 270 million. Around a third of the free cash flow was due to the decrease in working capital. Working capital continued to be supported by the low level of equipment sales. As long as this trend continues, together with a high proportion of equipment sales by credit card and cash, working capital will continue to decrease, which will probably impact on free cash flow.

The company’s net debt at the end of the quarter totaled NIS 4.2 billion, reflecting a decrease of around NIS 700 million over the last 12 months. Capital investments in the first half of the year totaled NIS 246 million. The company continued to make investments in infrastructure network and IT, and intend to invest at a higher rate in the second half of the year than in the first half. In view of the relatively high cash flow balance, we decided after the quarter end to take a number of measures to reduce the level of debt and financial costs. These measures include early repayment of bank loans, a reduction of credit facility and a debt buyback plan.

Due to the new royalty regulation, the average quarterly royalty expense in the second half of the year are expected to be lower by approximately NIS 12 million, compared to the royalty expenses in the second quarter.

Turning to dividends, the board of directors authorized a dividend distribution for the first half of 2012 in a total amount of NIS 1.03 per share or ADS, approximately NIS 160 million in total, equivalent of 60% of the company net profit and one-third of the free cash flow for the first half of the year.

And now I will 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 David Kaplan of Barclays Capital. Please go ahead.

David Kaplan – Barclays Capital

Hi, good afternoon everyone. This question I guess is for Haim. Haim, you talked about how you believe that the regulator is going to be required in order to get QA final solution on the wholesale operations. Yet one of the fixed line operators said that they believe that there will be an accredited before the end of the year. So can you tell us a little bit more about why you believe there were required interventions on the part of the regulator in order for us to see those wholesale agreements signed?

Haim Romano

The relation promised the revolution in the TV markets. And there will not be any successful revolution unless the price of the wholesale market will be different. And all our meetings with the Ministry have determined to finish this issue before the end of the year. He gave us six months to settle this issue with Bezeq and Hot. We are quite promising with Bezeq. And we have an agreement and overall, most of the items above the engineering regarding to the wholesale and still this agreement about the cost.

The problem is not for any of the sites, there is not a reference or a benchmark. It is different from the seller log in the seller market, when the MVNOs they started the negotiation, they had the reference. The reference was the interconnect. We don’t have reference for this negotiation. And we ask the ministry of the recommendation to give us the reference. And they haven’t done it yet. So we believe that the voluntary, nobody reduces the income just because he’s a nice guy. They need the pressure or the benchmark from the minister of telecommunication.

The ministry of telecommunication promised reform a promise of revolution in the wholesale market in general and in TV market in the specific terms. And I believe that he means it.

David Kaplan – Barclays Capital

Okay, this might be presumed, just thinking about the TV market and the over the top [inaudible] that will be required there, can you talk a little bit more about what the required SOB for you guys to roll out a full fixed line operations on wholesale of course?

Haim Romano

We didn’t disclose the amount of topic that will be required. But we are not talking about significant amounts. I would guess we are talking about a few thousands of millions of shekels in topics, not more.

We have no plans of spending hundreds of millions of shekels buying the content and paying in advance.

David Kaplan – Barclays Capital

If we look at what the TV operators currently pay for content and we see it’s hundreds of millions of shekels. It’s not a small number at all.

Haim Romano

Yes, but it’s not our approach. We’re not talking about hundreds of millions in content. And actually, we are very careful in signing contracts. And we decided not to sign any contract before we have the full improvement about the prices that we have to pay for the interconnector for what they call the wholesale market. But investments are not hundreds of millions, but much less than that.

David Kaplan – Barclays Capital

All right, I’ll let the line go for now. Thanks.

Operator

The next question is from Simon Morris of Citibank. Please go ahead.

Simon Morris – Citibank

Hi, good afternoon. Just a couple of questions. You spoke about working capital improvements in terms of equipment sales. But we haven’t actually seen in the actual numbers. I mean it is costing $7 million working capital benefit from inventory reductions. When can we actually expect to see a significant impact from this?

Haim Romano

There was a reduction in the working capital of NIS 17, NIS 18 plus a decrease in working capital.

Simon Morris – Citibank

Yes, but just in terms of the inventory line, I assume that is where most of it would come from, yes?

Haim Romano

Most of the reduction is coming from a reduction in AR.

Simon Morris – Citibank

Okay, fine. And just another question, on your dividends, you said your dividends for the first half is going to be 60% payout. I was just trying to understand in terms of, you say your policy is 80%. I mean has that changed or are you going to make up the shortfall in the second half?

Haim Romano

There is no change in the dividend policy, which is at least 80% on a yearly basis. So currently, the position was to pay 160, which is around 60% of the net profit for the first half. And it’s about 1/3 of the cash flow for the first half.

Simon Morris – Citibank

So if the dividend policy hasn’t changed, what does that mean? How come it’s at 60%? And just to clarify, I'm just trying to understand. Does that mean you will make up in the second half if the policy hasn’t changed?

Haim Romano

The policy is on a yearly basis. Every quarter, this issue is discussed by the board. And they make the decision. There is no commitment whatsoever that additional 20% will be paid. It might be more. It might be less. The decision will be made by the board in one of the next meetings.

Simon Morris – Citibank

Okay, all right, thank you very much.

Operator

The next question is from Leah Glazer of Excellence. Please go ahead.

Gilad Alper – Excellence Nessuah Investment House

Hi, it’s actually Gilad Alper. Just a question on the overall model. I mean you guys are making some gradual cost cuts. And you’re making some adjustments to the business model. But all and all, you’re working I think pretty similarly to the way you did last year, two years ago. What needs to happen in the market in terms of either market share loss or in terms of a declining profit for you to completely change the way you do business? In other words, what needs to happen for you to embrace the business model of Golan Telecom, which is in one source a headcount, which is a lot smaller than what it is now? Or an internet-based business model, what needs to happen for you to do that? Thanks.

Haim Romano

First, I am not sure that the business model of Golant Telecom is sustainable. You see what happened yesterday with the – when [inaudible] released their results and you can see that there are no free meals. So it’s – you don’t see what they are doing – they’re not [inaudible] and not Golan and not Hot Mobile. You can see the ARPU of Hot Mobile [inaudible] and we don’t really understand their expenses and revenues. So it’s still to be proved.

We change our model. We don’t work as last year. We don’t invest such amount of labor in our value chain and we managed to reduce 200 – sorry, 2,100 positions without reducing our service level around the country. Our service level is best – is better than it used to be in the last two or three years. [Inaudible] in our campaign with 0102. This is the way we introduce to the market the service that is local service and you can deactivate it by the Internet and we – by this segment and by this promotion we can – we understand that we can approach the customers that are not sensitive to service but are very, very price sensitive and are willing to get their service via the Internet. We feel that using the [inaudible] brands is a known telecommunication brand is the right decision instead of reducing the ARPU in our customer base according to the people that are asking for service.

So those are our two arms. We have the long one with Orange traditional brand with much more investment in the self-service and [inaudible] the service and the way we do business will be much more efficient. And the other arm, the short one is the [inaudible] and with full service via the Internet using mainly the [inaudible]. You can activate yourself, you can get the SIM card from any store [inaudible] store in the country and you don’t have shops, you don’t sell [inaudible] and such. So we have the two options; on similar to run but we think we are very, very efficient. For example, if you take a Golan system, if you lose your phone, it takes you three or four days to be without handsets. I don’t know if you are aware of that because they will send you the SIM card by the mail. We don’t do that and this is the easiest way to see the churn. So our customers in 012 can get any – at any time a SIM card from shops [inaudible] for example. So we are even better than Golan, you know, our way of doing business.

Gilad Alper – Excellence Nessuah Investment House

Okay, thank you.

Operator

There is a follow-up question from David Kaplan of Barclays Capital. Please go ahead. (Operator Instructions). There are no further question 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 1-888-295-2634, in Israel please call 03-925-5918, and internationally, please call 972-3925-5918. Mr. Romano, would you like to make your concluding statement?

Haim Romano

Thank you very much. We appreciate your time and see you next time.

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