Partner Communications Company Ltd (PTNR) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Q3 2005 financial and operational results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Tuesday, November 8, 2005.

I would now like to turn the conference over to our host, Mr. Dan Eldar. Please go ahead.

Good morning to our listeners in North America and good afternoon to those in Europe, the Middle East, and in Asia. Thank you for joining us for this conference call to discuss Partner Communications third-quarter results. With me on the call today are Amikam Cohen, the CEO of Partner and Alan Gelman, our CFO.

At this time, if you do not have a copy of today's release, please contact Yael Margoninsky. He can be reached at 972-544-814159 (ph); or in New York, Mr. Christopher Chew (ph) at 1-646-284-9426 and a copy of the release will be either e-mailed or faxed to you immediately.

Before we begin, I would like to draw your attention to the fact that oral 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 oral forward-looking statements, you should be aware that Partner's actual results may differ 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 8, 2005, as well as Partner's prior filings with the U.S. Securities and Exchange Commission on Forms 20-F, F1, and 6K, as well as the F3 shareholders (indiscernible) 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 the Internet and can be accessed through our website at www.investors.partner.co.il.

At this time, I would like to turn the call over to Amikam.

Thank you Dan. The third quarter we stepped up our efforts to make sure that Partner continued to lead the third generation revolution in Israel. During the quarter we more than doubled the number of our third generation subscribers to over 73,000 subscribers. The impressive number of new 3G handsets together with the uptake of our 3G services allow a portfolio of full high-quality third generation handsets; we are evidence of the continued success of our excellent quality network, our unique brand, and our innovative data and content services.

Going forward we plan to keep on growing range of third generation handsets we offer and expect that as the technology matures and as more handset supplies come on stream, handset costs and subsidies will come down over 2003. We are now nearing completion of the rollout phase of our third generation network and we are already providing third generation coverage to over 90% of the population in Israel. We see good usage patterns coming from our third generation subscribers and are extremely encouraged by what we have seen so far.

The results of our effort in this quarter to grow the third generation subscriber base are an investment in future growth and for profitability. We are confident we shall reap the benefits of this investment in the future.

With that said, I would like to hand the conference over to Alan Gelman.

Thank you, Amikam. This has been a quarter where we invested in two major courses of action for the future; one to promote future revenue growth and one to reduce future financial expenses. The first course of action was to temporarily increase handset subsidies as part of our 3G strategy and to establish future incremental revenue streams. As a consequence, the gross loss on handsets increased by approximately 40 million shekels compared with the third quarter of 2004 and by 35 million shekels compared with the second quarter 2005.

The second course of action was to redeem our expenses $175 million 13% senior subordinated notes as part of the restructuring of our debt into lower-cost CPI linked shekel-denominated debt. According to the terms of the notes, the redemption price was 106.5% of the principal amount. As the result of the redemption, we incurred to one-off charge in the third quarter in the amount of 63 million shekels. Both these actions had a significant impact of our quarterly operating results, but as Amikam said, we expect a positive impact in the future.

To return to our quarterly results, in the third quarter our revenues increased by 0.3% compared with the third quarter portfolio 2004 to 1,352.3 million shekels. This is despite the reduction in interconnect tariffs which went into effect in March 2005. Our EBITDA decreased in the third quarter of 2005 by 7.5% compared with the third quarter of 2004 to 382.7 million shekels from 413.8 million shekels for the third quarter 2004 and by 9.1% compared with 420.8 million shekels in the second quarter of 2005. As a percentage of revenues, EBITDA decreased to 28.3% of revenues in Q3 2005 or 30.7% in Q3 2004 and from 33.6% in the second quarter of 2005.

Financial expenses in the third quarter of 2005 were 148.8 million shekels. That is up 237.8% from 44 million shekels in the third quarter of 2004 and up 79.6% compared with 82.8 million shekels for the second quarter of 2005. The increases were primarily driven by a one-off charge in the amount of 63 million shekels related to the redemption of the U.S. dollar 175 million 13% senior subordinated notes on August 15, 2005.

Net income in the third quarter of 2005 was 30.9 million shekels, representing a decrease of 73.1% from 114.9 million shekels in the third quarter of 2004 and 73.3% from 115.8 million shekels in the second quarter of 2005. We expect the fourth quarter results to support the annual guidance we gave on February 7, 2005, since handset subsidies in the following quarter, Q4, will be lower than Q3. Our main objective is stated and the annual guidance is to maintain 2005 EBITDA at the level achieved in 2004.

Thank you, Alan. You are now invited to ask your questions.

(OPERATOR INSTRUCTIONS) Joseph Wolf, UBS.

I had a question about future revenues in light of -- if I look at 2005, I think that the puts and takes for the -- (technical difficulty) cut in the interconnect fee but some ability to raise pricing and then minutes of use have been up as well. When you think about elasticity of demand, competition, and your ability to raise or compete by reducing prices going forward, has this year been a year where you can learn something about that or is this year a year where the external factors played more of a role in your ability to price the product?

Let's say both of your statements are correct, Joseph.

We think no question about it, but the 29% reduction in interconnect rate was a major hurdle and a major challenge for us. And I think it is a challenge we succeeded in overcoming because as you see our top line revenues basically have not shrunk and we are going to manage to replicate the EBITDA which we had in 2004 and 2005.

That said, I think we learned a little bit about the market. The market is a very, very competitive market but if you act in an intelligent way in the market and it is possible to raise tariffs, we did raise tariffs. We also did restructure a lot of our tariff plans in our marketing and what I call our calling packages to our customers. And the bottom line is we managed not only to increase usage across the board on a customer base, we also did not incur a what I call anything more than an immaterial increase in churn. So the two things we really worried about was number one, will we be able to raise prices? I think we did it in a smart way. Of course we were helped out by that our competitors also raised prices. The rain rains on everybody the same and everybody took their actions what they thought was the right action to take. But I think the way we restructured our tariffs got the results across the board. In fact, if you look at last quarter's results, I can't talk about this quarter's results, I think we are the only self-owned company in Israel that managed to basically get an increase in revenue over and above what they had the year before considering the interconnect.

Going forward for 2006, I think we have another challenge in 2006 with the interconnect. As you know the interconnect rate goes down about another 9% on voice. In 2006, on March 1, 2006 and there is a further decrease in SMS interconnect tariffs and I think the lessons we have learned and how the market reacted in 2005 I think the challenge in 2006 is a challenge that we can succeed in.

Great. Thanks, Alan.

Yoav Burgan, Poalim Sahar.

I'd just like to know what would you expect the 3G subscribers to -- actually when would you expect them to significantly contribute to the general -- to revenue?

The main driver for 3G subscribers significantly contributed to revenue is where we have a critical mass of 3G subscribers. We made our first real effort to increase the 3G subscriber base in the third quarter. We believed that the timing was right. We had for the first time after having six months where we only had one handset, we had another three handsets in the marketplace. It was before the Jewish holiday season here, which started on October 1, and it was a good opportunity to run an aggressive marketing campaign to really jump start 3G. We believe that the campaign was very successful. We more than doubled our 3G subscribers. We got good results as far as data and content usage, and we believe that the process from here on in will run by itself without going through any real what I call aggressive campaigns and subsidies in the future.

We believe that we will have a further range of handsets in 2006. We hope to see those prices on handsets coming down and therefore we are very, very optimistic that our 3G subscriber numbers will grow accordingly. We do not expect the numbers in the fourth quarter to be larger as for as growth in subscriber numbers in the third quarter primarily because of the Jewish holidays in the month of October which you have less days of work. But we do feel that we can consistently add 3G subscribers in 2006. And depending on the price of the handsets, the delta between the price of a 3G handset and the price of a 2G handset is a very, very important driver in the process. As that delta gets smaller and smaller, you'll see more customers going over the third generation and you'll see more incremental revenue coming from third generation services.

We talked about it in our press release that we saw -- if you look at the content and data revenues in the third quarter 2005 compared to the content and data revenues in the third quarter of 2004 after you adjust them for SMS revenues which are not really related to third generation, we have a 50% increase in data and content revenues. That is driven by 3G subscribers.

So the initial results of 3G and the initial usage patterns of 3G are very, very encouraging. We don't share those numbers with you right now because we still don't have a very large base of 3G subscribers and that would be unfair to you and to our investors because a lot of those 73,000 new customers we would consider early adapters and the customer base is not representative in proportion to our full customer base.

Hopefully we will continue adding 3G subscribers at a healthy rate and when we get a critical mass of 3G subscribers, we will be able to share those numbers with you.

Okay, great. And the current 3G subscription base, the 73,000, how differentiated is their ARPU from the general ARPU?

That's exactly what I just told you. We can't share that with you right now. There is no question about it that they are using more than the second generation base and the fact that our data and content revenues grew by 50% between this quarter and the same quarter a year ago is indicative of that. But again, since they are early adapters, I think it would be unfair for us to draw any conclusions from those results.

Okay. And just one last question. Actually besides Q4, we should not expect any additional massive marketing campaign, 3G related, as was in Q3?

If you're talking about the subsidies, that's correct. I think 3G is becoming the focus of our marketing campaigns. We're going to continue marketing 3G. We're going to continuing spending more (ph) in 3G but our spend and our subsidies will be at what I call more normal level and we will stick to our guidance which we gave at the beginning of the year that we expect SAC (ph) to be in line or about same level as it was in 2004 and 2005. And if you recall the first two quarters it was substantially below that. That is because we did not have a selection of 3G handsets in the third quarter. Of course it was much higher. We expect the fourth quarter to be more in line with normal levels to SAC.

Okay, great. That's all for me. Thank you, Alan.

Istvan Mate-Toth, Credit Suisse First Boston.

I have a related question to the previous one. Going into 2006, should we assume that there will be a great variability in your margins as you will continue to emphasize some of these marketing campaigns for 3G? I fully appreciate that at this time you are reluctant to share the business model with us or some of the KTIs (ph). Nevertheless would it be fair to say that you will be adopting a more aggressive stance on promoting 3G; therefore, there is a chance that margins for the full year '06 will come in a little bit lower than they will be in 2005?

And the related question I have is what is the key strategic rationale for you to be very actively promoting the take up of 3G in your subscriber base? I think I understand your parent has a fairly mixed experience with that in Europe and I have the impression that in Europe some of the big incumbents are much more relaxed or prefer a much more gradual approach. What is your key reason that you want to be a bit more aggressive on that?

Let me take the first question first. With regard to 2006, there is no question about it that the emphasis of our marketing campaigns is going to be on third generation because we believe that in a couple of years all our subscribers will be third generation. We don't think it is a big decision-making thing. If the delta between the handset prices are pretty small, the possibilities and the products, the variation in the offering that is offered to a third generation customer and the quality of that offering compared to second generation is just huge and the customer experience is fantastic. We have no question in our mind that we will be able to generate additional revenue there.

That said, I don't think it's going to create margin pressure in 2006 for a different reason. The margin pressure you see here and I'm not sure which margin pressure you're talking about but if you are talking about operating profit margin pressure in 2005, it is more because our third generation network was built out and we have depreciation expenses and maintenance expenses and we don't have a lot of third generation customers to support those expenses. So we do see margin pressure in 2005. I think the margin pressure in 2006 will be less.

In other words, I think between expansion of margins on the operating level, also because we will have less depreciation on the second generation network where we will finish depreciating our initial investment on a second generation network which was established in 1999, by the end of 2005. And therefore you're going to have depreciation expenses in 2006 pretty much in line with depreciation expenses in 2005. Whereas in 2005 we had two sets of depreciation, we had a full set of depreciation on our second generation network. And we had full depreciation of third generation network with not a lot of incremental income to offset it. So I think from the point of view of margin pressure, I think you should not see anything unusual in 2006. And I think we should see -- you know, what you saw here in the third quarter is definitely a one-off and I think you will see margins that are better in 2006 than you saw in 2005, especially at the operating profit level where we don't have the additional pressure of the additional depreciation.

I'm sorry, Alan. I was really sloppy. What I think I meant was there was a tremendous increase in acquisition costs. Obviously as you say, some of these new subscribers that (technical difficulty) and probably higher revenue generators and so on. So my general question was whether with increasing 3G we will have a reversing of the economy or a revenue payback, (inaudible).

I'll answer that also. I don't think you are going to see a material difference between what we're subsidizing handsets in 2006 and 2005 on a year-to-year basis. We expect 3G handset prices to keep coming down and therefore that puts a lot less pressure on us to subsidize the handsets in order to promote third generation. So our view is that you are going to see -- you're not going to see a lot of margin pressure from the handset prices and from 3G strategy in 2006.

The second part of your question was why. You understand the motivation of our parent company but you find that most European companies are more relaxed with respect to 3G. I think our strategy is different than our parent company. I think we have a more relaxed strategy to third generation also. I think we view third generation as a natural evolution from the second generation customers. We're migrating our customers from second generation to third generation and we're going to do it in a very, very what I call in -- I wouldn't say conservative way but we're going to do it as an actual way without forcing the issue.

The whole issue of the third quarter was something we had a lot of thought about when to start the process to third generation, when is the right time and how intensive to make the jump start of our third generation process. Given the fact that we had a larger selection of handsets which was one of the major problems in getting the process started and getting the public to understand that there is third generation in Israel, we decided that it would be best to run a very, very aggressive campaign, marketing and with handset subsidies before the Jewish holiday to make the impact to basically make a statement third generation is here. We have the best product. We're the leaders in the market and I think you're going to see our policy with respect to third generation being a more relaxed policy in the fourth quarter and in 2006.

That's very helpful. Thank you very much indeed.

Benita Mikolajewicz, ING.

I have three questions, if I may. First one is on your gross margin on service revenues. Excluding essentially equipment sales, I'm looking at gross margin. It seems that it dropped by 2 percentage points between second quarter and third quarter. So in other words, essentially 5 percentage points of your drop in EBITDA margin, essentially 3 percentage points is explained by handset subsidies. And my question is what are these other 2 percentage points if you can elaborate on that?

Also I'm just wondering if you can tell us a little bit more what the competition is doing right now in terms of handset subsidies? And how do you compare with their offerings? Also in terms of your new subscribers including 3G subscribers, maybe you can tell us what are they coming from? The 3G subscribers, are they coming from your 2G subscriber base or from competition? Maybe you have an estimate of this trend.

That's a lot of questions. I'll take the last one first because that's easiest one to answer and that is just factual. Most of our customers come from upgrades. At this point, most of customers -- we don't give out that number, the exact number, but most of our customers come from customers migrating from our second generation network to our third generation network.

With respect the second question, which is competition, the handset subsidy, this is a very competitive market. Both our competitors are aggressive on the handset subsidies. They do not share that information as far as what level of subsidies they have, at least not all of them do and they don't share it on a consistent basis. But to draw a conclusion, a factual conclusion who is more aggressive and who gives the largest subsidies, I can't really give you a clear answer on that. But it is acceptable in this market and it is modus operandi on this market that our competitors do subsidize handsets and sometimes aggressively.

If we look at the first question, which is a more complicated question, I basically say what caused the reduction in margin on service revenues? Some of that has to do with the continuing dilution in price per minute. If you look at our ARPU, our ARPU went down by 8%. But ARPU went down 8% predominately because of the interconnect rate, the 29% reduction in the interconnect rate but our MOUs are also going up. But we still do have some dilution in the tariff across all sectors, especially in the business sector, which is the most competitive sector.

More importantly in the third quarter, which is the summer months, we generally have specifically in this quarter we have certain seasonal expenses which we don't have with the same impact in the winter months. For instance as you look at the actual margin of some of the services, for instance roaming services or some of the roaming services, it is a lower margin than other services. There are more people that come to our service centers in the summer months than in the winter months. So we do have what I call margin pressure in the third quarter, specifically in the third quarter. That is something that is really more seasonal and that is something that what I call part of the structural part of our offering. Other than the fact that we can still expect the gradual tariff dilution continuing also in the fourth quarter and in 2006.

Sure. Maybe a follow-up if I may. On the customer numbers and you said that they are coming mostly from upgrades. So the question is whether we're going to see larger internal numbers going forward? And also you have mentioned that of course market is highly competitive and both competitors are offering high handset subsidies. I guess that you cannot really afford not offering handset subsidies or not as big as your competitors going forward. So what sort of -- why are you so convinced that your competitors are going to behave more rationally with this respect?

I think there is rational competition in the market. The fact that the market has aggressive competition, I'm not saying that people are making decisions which are not economically motivated. It is the modus operandi of this market that people -- that our competitors do subsidize handsets. It has been that way for the last couple of years. It is always aggressive to think that in 2006 that policy is going to change. We look at the market very intelligently. We look where we want to subsidize handsets; where we don't subsidize handsets. We're very careful for instance not to subsidize handsets in the prepaid market. And we very, very rarely subsidize handsets in the postpaid market. Most of our subsidies are in the business market, which is the most competitive market here in Israel.

I don't see any real fundamental change that's been happening in 2006. I don't think the market is going to get more aggressive in 2006. I think we can expect a similar level of competition in 2006 and because the market is more mature and more penetrated, you can expect slightly higher churn rates in 2006 than 2005. I don't think you're going to see any major change in churn rates in 2006 versus 2005. There is the regulator here in Israel, (indiscernible) institute number portability but that will probably be in 2007 and therefore I don't think you're going to see any impact of that in 2006.

Sure. Thank you very much.

Stephen Pettyfer, Merrill Lynch.

Three questions if I may. Firstly you seemed relatively confident about lowering subsidies in the fourth quarter. I just wondered if that meant that you had increased handset prices or you saw lower handset costs coming through?

Second question is on working capital. I guess an expected blip in working capital given the push in 3Q, should we expect that to normalize going forward or are we at a higher level there?

And thirdly, perhaps ambitiously, are you in a position now to give us any thoughts about CapEx for 2006, given your comments about how complete you are with 3G coverage?

Let's start with the last one first again. CapEx 2006 will definitely be lower than CapEx in 2005. We've pretty much completed our coverage of the third generation network. We have almost complete national coverage of the population center and in 2006, most of our focus is going to be towards building for capacity and that will be driven by subscriber growth. How successful we are in migrating our customer base from second generation to third generation, so you will see lower levels of CapEx in 2006 which should boost our working capital.

You mentioned working capital pressure. If you look at working capital pressure, I think working capital pressure if you're talking about the cash flow in the third quarter, which was lower than the previous quarters, a lot of that has to do with the one-off item, not only with the handset subsidies, but it also has to do with the one-off we had on redeeming the bonds. Of the 63 million shekel write-offs, 52 million shekels of that write-off was in cash.

We are also continuing with our policy which is a change this year of not factoring out our receivables, our credit card receivables for handset purchases which are paid over 36 installments. We're doing that by ourselves right now and therefore that in itself has reduced the actual cash flow but has saved us and will save us in the future a fair amount of financial expenses.

Going forward I think you can see a little less extreme change in the other changes in working capital because of the 36 payments because as we go further and further into the 36 payment plan, you are going to see more of those long-term payments becoming short-term cash. So you're going to see less of a difference there and you will less CapEx and you won't have the one-off items which we had in the third quarter. So I don't see any fundamental change in our projections as far as cash flow is concerned going forward.

With respect to your first question, that we are comfortable. We're comfortable because we made that decision. We think that the promotion we did in the third quarter was highly successful. We got a good base of subscribers using third generation. We see that the momentum has continued into the fourth quarter without us issuing -- without us offering huge subsidies. Yes, we have increased prices and therefore there is a lower subsidy level. And we are starting to see reduced prices to handsets with the manufacturers and the visibility for 2006 is that those prices will come down further. If those prices come down further, some of that will pass on to the customer. And some of that will reduce subsidies even further.

Thanks, Alan.

There are no further questions at this time. Would you like for me to repoll?

Thank you very much. This concludes this conference call for Partner Communications. I would like to thank you for your participation. Access to this call and to other available information on Partner is available through our Internet site at www.investors.partner.co.il. Thank you and good morning in North America; good evening in Europe, in Israel and Asia.

Ladies and gentlemen, this conference will be available for replay after 7:30 PM Israel time today through November 15, 2005 at midnight Israel time. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 801632. International participants please dial 320-365-3844. (OPERATOR INSTRUCTIONS) That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.