Partner Communications Company Ltd (PTNR) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter financial and operational results conference call. At this time all lines are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during this call, please press star then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Dan Eldar. Please go ahead, sir.

Thank you very much, Morgan. Good morning or good afternoon, and thank you for joining us for this conference call to discuss Partner Communications second quarter 2003 results. With me on the call today are Amikam Cohen, CEO Partner's and Alan Gelman, our CFO. At this time if you do not have a copy of today's release, please contact Ms. [Inaudible] at 972-485-14159 [inaudible] or Mr. Robbert Sherone at New York at 1-646-284-9430, and a copy of the release will be either emailed or faxed to you immediately. 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 the U.S. Private Securities Litigation Reform Act of 1995. In connection with such all 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 [inaudible] that could cause actual results to differ materially from those in the forward-looking statements are contained in Partner's press release dated July 30, 2003, as well as Partner's prior filing with the U. S. Securities and Exchange Commission on form 20S, [inaudible] M6 K [phonetic], as well as [inaudible] the 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 may be relied upon subject to the previous Safe Harbor statements as of the date of this call. For your information, this call is being broadcast simultaneously over Internet and can be accessed through our web site at www.investors.partners.co.im. At this time I'd like to turn the call over to Amikam. Amikam.

Thank you, Dan. The second quarter of 2003 is a record quarter to Partner. Despite the consistently challenging economic environment, we continue to improve our operational and financial performance. We've also continued to demonstrate our ability to maintain tight control over our costs and to improve our growth and to improve our share margin significantly. Our [inaudible] strength is marketing, customer service and [inaudible] strategies, along with our outstanding grant (ph)we continue to differentiate our company from our competitors and drive our growth and profitability. At the end of the second quarter we'll reach 1.949 million subscribers, approximately 29% [inaudible] the market in Asia. We registered net profit of 165 million shekels [inaudible] and 348 million shekels, 32% of our revenue and an operating margin of over 20%. We continue to generate free cash flow for the fifth consecutive quarter. This quarter we generated approximately 131 million shekels of free cash flow, and over the last five quarters we reduced our open debt by 322 million shekels. We also succeeded in raising our capital deficiency accumulated during our start-up during the early years of operation. We finished the second quarter of 2003 with [inaudible] of approximately 97 million shekels. Although we are still in the midst of economic slow down which is affecting the general business community and spending power of the consumer segment, we're comfortable that we will continue to manage the [inaudible] performance while continuing to grow our subscriber base and revenue and by tightly controlling our costs and hedging our ability to maintain our profitability growth. [Inaudible] core development we're carefully watching the [inaudible] in the region. I'm confident that in the process [inaudible] it will have a significant beneficial effect on the future economy and [inaudible] in the consumer community and the business environment in Israel. We believe that whatever the macroeconomic geopolitical conditions may be, we have significant [inaudible] that will help us to continue to create revenue for our shareholders. Such is our brand which was just determined to be the most variable brand in the telephone industry in the world. Second in strength only to Coca Cola in the consumer market in Israel. The quality of our customer service, rated number one in the cellular business by Israel most of business management center. With this [inaudible] I'd like to turn the call over to Alan Gelman to summarize the financial and the operational results for the second quarter. Alan.

Thank you Amikam. Good afternoon and good morning everyone. We're very pleased with our financial results for the second quarter. Our record results were driven primarily by effective cost management, increasing usage by the subscriber base, seasonal factors and tarrif adjustments. We believe we've upgraded our level of performance; and this new level, subject to seasonal fluctuations, is sustainable in the near and midterm. We believe that we've established fundamentals that will enable us to build on this firm foundation, giving us the platform required for expanding margins in the future. As Amikam said, the major story of this quarter is the level of profitability achieved. The most significant achievement was our ability to reduce our cost of sales, even though our revenues are expanding. We did so primarily by scaling down our costs related to customer handsets and maintenance, network maintenance and logistics, all without compromising the high level of service we provide our customer base. As a result of our effective cost management, every shekel of incremental revenue compared to Q2 2002 directly increased our gross profit. Compared to Q1, 2003, our gross profit exceeded almost two fold our increase in revenue. We also continued to maintain stable levels of SG&A, levels similar to those expended in 1999 where we had revenues that were approximately 20% of where we are now. Financial expenses were significantly lower in Q2 versus Q1. The reduced financial expenses were primarily due to a stronger shekel which accounted for net of hedging transaction, approximately 19 million shekels of the improvement. The balance of the improvement is the result of our strong cash flow, which has reduced debt levels and interest costs and the reduction in local interest rates as mandated by the Bank of Israel, Israel's central bank. We believe that our consistent cash flow generation and the remaining availability from our credit facility should allow us to execute our business strategy without any additional injection of capital or the need of any additional credit facility or debt instrument. Looking forward we expect another strong quarter in Q3 2003, with operating results similar to Q2 2003. With regard to our key business indicators, subscriber growth remained healthy at levels similar to Q1; and we expect continued healthy growth at levels slightly lower for the balance of 2003. MOU and ARPU increased, and our stat (ph) was within the range of guidance we provided the market. Looking forward to Q3 we anticipate similar levels of MOU, ARPU and stat. Our CAPEX levels continue to be low. For the second quarter-- second straight quarter we invested approximately 6% of our revenues in additional CAPEX. In anticipation of the upcoming buildout of our third generation network, we expect to continue invest substantially less in second generation capital expenditures than we did in 2002 for the remainder of 2003. That said, the start of the buildout will be finalized in accordance with the [inaudible] three G networks worldwide and the competitive landscape in Israel. We do not expect to role out a commercial network before 2004.

Thank you very much, Alan. You are now invited to ask your questions. Operator, please.

Ladies and gentlemen, if you wish to ask a question, please press star and then 1 on your touch tone phone. Will you hear a tone indicating your line has been placed in queue, and you may remove yourself from queue at any time by pressing the pound key. If you are using a speaker phone, please pick up your handset before asking a question. Our first question comes from the line of Alice Wright [phonetic] with UBS Warburg. Please go ahead.

Good afternoon, gentlemen. I see you've had a very successful quarter in terms of achieving a high level of profitability, and in your press release you attribute a large part of this to the efficiencies that you've achieved in handsets and network maintainance and logistics. I'd just like to ask really if you could give any detail on how exactly you've achieved these improvements? Has it been through the renegotiation of existing contracts? How do you manage to bring prices down so much, if that was the case. And secondly, would you be able to quantify, first of all, the amount that you now expect to spend on an annual or a quarterly basis on each of these items, and also if you could give us any kind of idea if the amount that you saved over the course of the last quarter on those items. Okay.

Alex, how are you? First of all, of course I can't give you all that information because some of that information is -- I would call it of a competitive type of nature; but I'll try to answer the question as best as possible. First of all, the way we say the expenses, the way we became more efficient, was not necessarily renegotiating contracts. We're talking about complicated processes here, dealing with the handsets that we supply our customers. Of approximately two million subscribers which means we have two million handsets, and probably unlike what goes on in the UK, we are basically the source where handset owners come to when they have a problem with their handsets. So we're dealing on a customer basis with what I call repairs of handsets, swaps of hand sets, upgrading handsets, et cetera et cetera. What we've done is on a couple of fronts -- first of all, the issue of upgrade. We've refined our criteria. We've -- we're becoming more focused on our criteria. Cut down on basically what I would call unnecessary upgrades and really concentrating on the upgrades which, when we do upgrade, we incur a subsidy on that particular handset. We save some expenses there. The majority of the expenses that we save are in the area of what I call the logistics of replacing handsets for subscribers. A subscriber who has a handset that doesn't work basically comes to one of our customer service centers or gives us a call. Either we send him a message, or we change his handset or he comes to a customer service center and we fix the handset or we give him a new handset, et cetera, et cetera, et cetera. What we've done is we've worked on those processes. We've cut down the amount of replacement handsets which we supply subscribers. When they have problems with their handsets we're doing more of the repairs in-house. We've cut down on our inventory level, and we've basically made all logistics processes much more efficient. That is most of the cost savings which we've had on the cost of sales level. In addition to that, we've also achieved some efficiency by the network maintenance, improving our contracts with network suppliers, maintaining our sales site in a more efficient fashion, transmission -- renegotiation of our transmission contracts, the transmission between the cell site and the network. So we actually worked on a large number of fronts. As far as quantifying the amount for each of those items we're not going to do that because we don't want to give that information to our competitor. The results you see in the reduction of cost of sales. What I can assure you is is that this is -- these are not one time items. What you will see is you'll see this is the new level of expenditures which we feel that will be at least the base level which we can improve on further in the future. What we do feel is that this is the level we'll see in the third quarter, and that we can replicate these results in the third quarter.

Okay, thanks, Allen. Just going on from that, you mentioned that you think these kind of levels of costs are sustainable. Your gross margin in the second quarter was several percentage points higher than it ever has been. You're basically suggesting that the gross margin of, well, just over 31% in Q2 can be at least maintained and possibly improved from here? And then secondly just looking at the SG&A, the SG&A items have been more or less flat now for the last six quarters or so. Is that the kind of trends that you think is sustainable going forward from here?

[Inaudible] I think our SG&A has been sustainable since 1999, even though our revenues went up five fold since then. With regard to cost of sales and gross margins, unless -- what I said is that we've reached a new level. We've upgraded a level of the profitability of the company. With regard to the actual margins, there will always be fluctuations in margins. You know, there are quarters where there are seasonal effects. There are quarters where the mix of your revenues are different. There will be revenues but at different profitability than other revenues, data revenues -- a different profitability than voice revenue. Our balance - and for the near to midterm I think you're going to see absolute margins and profitability margins. The subject of the fluctuations of the seasonal effect are pretty much the same level as they are in the second quarter. I think the next step up [inaudible] margins will be more in tune with handset prices start coming down, when the more advanced headsets with more data capabilities - the prices come down they become more appealing to the mass market; and then we'll be able to expand our data and content revenues at a faster rate. But until then I think you're going to see margins in the next couple of quarters -- similar levels to what we see of them right now.

Okay. So just finally on that point, are you in a position to change your official guidance on EBITDA margins for the second half of this year, which was basically approaching 30% in the third and fourth quarter?

Well, I think approaching 30% is quite persuasive. We already passed the [ 30% in the second quarter, and we expect similar margins in the third quarter. The fourth quarter, of course, Alex, you know I reiterate the fourth quarter is always the weakest quarter of the year because of seasonal issues. It's the winter months. So I'll reserve my judgment as far as the fourth quarter is concerned; but there's no question about it that excluding again -- I reiterate excluding seasonal issues -- we're at a new level of [inaudible].

Thank you very much.

You're welcome.

Our next question comes from the line of Stephen Levey with UBS Warburg. Please go ahead.

Good afternoon gentlemen, just two questions from me. On 2 G CAPEX you seem to be running about 60 to 65 million shackles a quarter. Is that the kind of run rate we should expect going forward for 2 G CAPEX.

It might be a little higher in the third and fourth quarter. We can't guarantee that we're going to keep the same rate - seizing the opportunity on a consistent basis is optimizing the network and trying to keep second generation CAPEX at a min. These could be increases, or we could maintain the same levels. All in all, what you will see for the balance of 2003 is much lower levels of CAPEX than we had in 2002, including any investments we might have in third generation, building out the first stage of our third generation network at the end of 2003.

Just finally for me. The Greunaur [phonetic] Report has made some relatively important changes to the way BETHEC (ph) collect its debts and the impact it will have on the cellular companies. I think BETHEC has said that the overall impact for them will be about 50 million shekels. Is there an expectation here we should expect the pro rata impact positively for Partner in the coming quarters on the back of that?

We expect that the decision that was made by the [inaudible] Communications will -- if it becomes final doesn't [inaudible] the right to appeal it -- but the decision will contribute about 20 million shekels to our P&L, and it would beef up our financial expenses by 20 million shekels. We recorded that in our quarterly financials as a subsequent event. And if that decision in fact becomes final, and BETHEC does not appeal that decision -- and we don't know if they will or they won't -- it might be reflected in our third quarter through them.

Thanks very much, guys.

You're welcome.

Our next question comes from the line of Neil Wedlake from Morgan Stanley. Please go ahead.

Hello, gentlemen, and congratulations on the step up in margin we've seen this quarter. I just wanted to return just briefly to this theme of sustainability. I understand clearly that you've put in some new processes to control costs in the existing business, but what would be the impact of 3 G roll out from next year? Could you perhaps give us some color as to what you may see happen in terms of SG&A expense, for example, as the upgrade cycle comes through? And whether indeed you might find similar problems with the kind of distribution and logistics costs that you've been talking about in terms of supporting the rollout of 3 G. And then a related question on the level of 3 G CAPEX, I understand that you're looking to appoint a supplier at some point in the next couple of weeks. Would you be able to give us an update on the expected cost of rollout and when you would expect to accrue most of that expenditure?

First question first. With regard to 3 G, we do not expect higher levels of OPEX than cost of sales on 3 G. There might be a certain very, very brief period where there's a certain amount of overlap, but we don't think it will be anything material. Our intent is to roll out our 3 G network gradually, do a final user trial - hopefully by the end of 2003/beginning of 2004, and then gradually roll out that network. We expect that there will be a transference, a certain transference of expenses from second generation to third generation; but our intent is to keep the level of expenses in the company pretty much at the same level. I think the procedures we have in place and how we deal with handsets -- I think the same procedures will be followed with 3 G handsets, and I believe that we will be able to achieve the same results on the third generation. With regard to 3 G CAPEX, we have given guidance in the past that the CAPEX will be about $350 billion, including our license fee which we paid. We're now changing that guidance. We are going to incur CAPEX expenditures which will be substantially less. I can't tell you exactly how much right now because we're negotiating with four vendors. Hope to make a decision within the next month. But the results of the tender and the offers we got from the vendors substantially reduce our expectation and how much we're going to pay on network CAPEX for third generation. I reiterate that we believe that even with third generation CAPEX in 2004, we will stay at CAPEX levels which will probably be below or at the very worst the same levels which we had CAPEX in 2002, and that we'll be able to fund all that CAPEX and the operating cash flow of the company.

Thanks a lot. Can I just get back to the first point on the margin. I appreciate what you're saying in terms of moving on to transfer these costs from one bucket to the other, as it were, with 2 G and 3 G businesses; but if you look at the individual components and look at subscriber acquisition costs for one and potentially the cost of generating content to drive your data strategy, do you not anticipate that that will put some marginal pressure on EBITDA margin?

No, we're not intending to change our policy on [inaudible] level on third generation. We also are not banking on an immediate list of data in content revenue from third generation.. I think what we're trying to do is position ourselves. We'll position ourselves gradually. We don't expect the data content revolution to explode overnight. We do expect is to maintain our position as the most advanced and the most attractive cellular company in Israel. We still believe over the next couple of years that most of the revenue growth is going to come from subscriber growth and be relatively consistent with subscriber growth which we've had in the past.

Do you think from subscriber growth rather than from expansion of data revenues?

At the beginning, no question about it. It's going to be more from the expansion of subscriber growth than from data revenue. Data revenue will expand only when the price of 3 G handsets come down. We don't expect -- we don't want to get involved in what I call heavy SEC, that's subsidizing very expensive handsets. As enhancement prices come down, that will be the driver for more data and content revenue.

Thank you very much. And congratulations again.

Our next question comes from the line of Steve Frank with Morgan Stanley. Please go ahead.

Steve Frank on the credit side. Can you help us understand your market share targets over the next couple of years? You're at [inaudible]%, you picked up 1% in the quarter.

I'm sorry, you'll have to repeat the question because your question broke up over the line. I didn't understand it.

Okay. Can you hear me me now?

There's a little echo. I don't know if you're on a speaker phone, but it's difficult to hear you.

Can you give us a market share target over the next couple of years, you're at 29%. Now, do you think you can get to about 35% over the next couple of years? Is that progressive?

I wish you were right but we don't think we'll have 35% in the market within the next couple of years. I mean we would like to be there. We expect to expand our market share, but 35%, depends on what you call the next couple of years. If it's the next two years, I think that's very, very aggressive. Hopefully we can get there. That's not exactly in our long-term plans. We want to be the most profitable cellular company in Israel. I think it's more important to us than actual market share. We're placing a lot of emphasis on bringing good quality customers to the table rather than just customers that are customers and don't use the handset at all.

Okay. Can you help us understand the magnitude of these 3 G -- the CAPEX for 3 G? Hais it fallen by half? Is it that much, or is it just the 25% error cut, do you think?

I really don't want to get into that because we're still involved in negotiations with the four vendors. And it's at a very delicate stage where we're finishing negotiations and we hope to appoint the vendor within the next four weeks. But what I can assure you is that the original guidance we gave of the amount that we will pay for network equipment under third generation will be substantially less.

Okay. Thanks very much.

You're welcome.

Our next question comes from the line of Istvan Matetoth from Credit Suisse First Boston. Please go ahead.

Good afternoon. Alan, when you said that you think that Q2 performanceis sustainable for the rest of the year, could you elaborate a little bit on the outlook for the revenue growth? Do you think that there is still -- do you feel comfortable given the pricing environment, given the degree of competition in the market that this figure of revenue growth that you've seen Q2 versus Q1 is sustainable, or you would rather feel more confident over the absolute level of revenues going forward, rather than revenue growth?

[Inaudible] revenue growth is sustainable. We gave guidance -- we're not changing our guidance which we have given prior. We felt year on year 2003 over 2002 we had 7 to 8% revenue growth, and I think that's where we're at. As you look quarter on quarter, our revenue growth was about 9%. I think that validates our estimates. The other thing happening in the marketplace that would indicate otherwise -- I think we took into consideration where we told you 7 to 8% that we felt that the market is still struggling a little bit. That's almost because the cellular market is struggling but because the Israeli market is still in an economic downturn. Hopefully we'll come out of that downturn, but we took that into consideration when we talked about revenue growth. I don't think there are really any new developments around that would down size our projections. In addition, I don't feel that we'll have any -- I don't feel we'll be more aggressive on those projections. I'm very comfortable with them.

Okay. Thank you very much.

You're welcome.

Our next question comes from the line of Daniel Moran [phonetic] From IBI. Please go ahead.

Congratulations on a great quarter. A couple of questions. First of all, can you give us any update on the partnerships for the time that you're discussing your plans on going to the international market, whether through partnerships or other means? That's one. Second, a lot of the initiative that Bezek (ph) is taking called B 1 targeting the business market with the integrated offering coming from Pelephone, Bezek International and Bezephone (ph) -- how are you going to align yourself against that? And last, the impact of this case marketing campaign on your results if at all.

Okay, three questions. Let's start with the international operator issue. We have stated previously that we view ourselves as a company which is focused on its cellular business. We will be looking at opportunities to expand the business to other areas of communication, but it will still be focused upon the cellular service that we are providing. We have not made any decision about entering the international operator business because the regulator, the Ministry of Communication, has not yet published relevant regulatory environment. Therefore we're not in a position to make a decision but unlike some other players in the Israeli market, our strategy is not to be a telecommunication company which provides under one roof all communication services. We believe there are opportunities to bundle services without actually providing these services by ourselves. With respect to the basic B 1 initiative, I think there's continuing regulatory discussion with the Ministry of Communication and with the anti trust commissioner about the mode of operations for the B 1 initiative. We believe we will be able to come up with the adequate answers, primarily by aligning our business book position with other players in the market whether it will be international, Internet or other areas of telecommunications. With respect to Escape. As you know Pelephone has launched a new brand in January of this year and the recent reports that we've seen in the market where Pelephone has recruited approximately 95,000 subscribers to this new rate plan, most of them have been recruited from the lines of existing Pelephone subscribers, obviously it's too soon to judge if the new brand will have a significant influx on this market. At this time we believe that in the segment in which Escape was planned to help Pelephone, that's the younger population segment, we are seen leading, and this business leadership position has been substantiated by some independent reports.

Okay, thank you. Can you give us the data, ARPU from your revenue?

It's approximately seven and half percent of ARPU and approximately 7% of total revenues.

Thank you.

You're welcome.

Ladies and gentlemen, if there are any additional questions at this time, please press star and then 1 on your touch tone phone. Once again, if there are any additional questions, please press star and then 1 on your touch tone phone at this time. There are no further questions, sir. Please continue.

Thank you very much. This concludes then this call of Partner Communications. We'd like to thank you for your participation. Access to this call is available to our international partners, available at our Internet site at www.investors.partners.co.im (ph). Thank you and good morning in North America. Good evening in Europe and the Middle East.

Ladies and gentlemen, this conference will be available for replay today after 8:45 p.m. Israel time through August 5th at midnight. You may access the AT&T Executive Replay Service at any time by dialing 1-800-475-6701 and entering access code 692108. International participants may dial 320-365-3844. Again, those numbers are 1-800-475-6701 and 320-365-3844, access code 692108. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect. (Concluded at11:40 A.M)--- 0