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Executives

Porat Saar – IR

Nir Sztern – CEO

Yaacov Heen – CFO

Analysts

Gilad Alper – Excellence Nessuah

Dov Rozenberg – Clal

Alexander Balakhnin – Goldman Sachs

Louie DiPalma – William Blair

Nicole Gilliat – Ion Asset Management

Lindsay Earl

Cellcom Israel Ltd. (CEL) Q4 2012 Earnings Call March 4, 2013 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Cellcom Israel Ltd. Fourth Quarter 2012 results conference call. All participants are at present in listen-only mode. Following management’s formal presentation instructions will be given for the question and answer session. (Operator Instructions) As a reminder, this conference is being recorded March 4, 2013.

I would now like to hand the call over to Ms Porat Saar of CCG Investor Relations. Ms. Saar would you like to begin?

Porat Saar

Thank you, Deena. I’d like to welcome all of you to conference call and thank Cellcom Israel’s management for hosting this call today. With us here are Mr. Nir Sztern, CEO; and Mr. Yaacov Heen, CFO. Mr. Sztern will open by providing summery of the main highlights of the fourth quarter and full year 2012 results; followed by Mr. Heen who will review Cellcom Israel’s financial performance in further detail.

Before I turn the call over to Mr. Sztern, I would like to remind our listeners that in this call management’s prepared remarks contain forward looking statements which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions. Therefore the claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995 and in the Israel Securities Law 1968. Actual results may differ from those discussed today and therefore we refer you for more detailed discussions of risks and uncertainties in the company’s filings with the Securities and Exchange Commission including under Risk Factors in the company’s Annual Report for the Year Ended December 31, 2012, 20-F filed today with the SEC.

In addition, any projections as per the company’s future performance represent management’s estimates as of today March 4, 2013. Cellcom Israel assumes no obligation to update these projections in the future as market conditions change. You should have by now received a copy of the company’s press release. If you’ve not yet received so, please call CCG Investor Relations at 1-646-233-2161.

I would now like to hand the call over to Mr. Nir Sztern. Nir?

Nir Sztern

Thank you, Porat. Good day, everyone, and welcome to our fourth quarter and full year 2012 earnings conference call. At the start of 2012, we outlined a strategy for the year to focus on mergers, synergies and efficiency. While 2012 was a year of major challenges for the market and for our group, it was also a year of intense activity for us during which, I believe, we successfully implemented the goals we laid out.

2012 can be characterized by the changes we have seen in the competitive landscape. The entrance of three MVNOs, along with two new UMTS operators led to intensified competition with dramatic price drops in the cellular market and the entrance of HOTnet to the ISP market had pushed home Internet prices down. The intensified competition in all lines of business led to an adverse effect on the group’s revenues which you see on both the quarterly and annual comparison. So long as price remain at the current level, we will see a continued adverse effect on our profitability going forward.

In 2012, we completed a complicated merger of two large companies at remarkable speed and quality, while achieving all the ambitious and synergistic goals that we set out for ourselves. Today, we operate with a unified headquarter and sales and service units, which offer a wide variety of mobile and landline communication services to our customers.

Netvision continued to grow in the total number of landline phones, reaching over 112,000 customers. Despite intense competition in the ISP market, we grew in the total number of Internet customers. All that growth was accompanied by cost cutting enabling Netvision to achieve an annual EBITDA of ILS 283 million.

Also this year, the group implemented an aggressive efficiency strategy in all areas of its operations, which lead to savings at an annual rate of approximately ILS 550 million. Specifically, we improved processes, optimized our operations, reduced head count by over 1,800 positions and cut expenses, all while continuing to provide high level of service in our call and service centers. As we move ahead in 2013, we continue to implement additional efficiency measures.

As we outlined before, our marketing focused on promoting bundled packages of mobile and landline services. We launch our Cellcom Total plan which saw great success, allowing us to maintain higher ARPU and lower churn. Despite our efforts to focus on higher ARPU pricing plans, our competitors continued with very aggressive marketing plans, reaching new lows. This led to a significant decrease in revenues, as I mentioned before. We see these trends continue into 2012 and we expect it to further adversely affect our results in the first quarter of 2013.

In 2012, we included the IDF to our customer base and successfully retained our position as market leader in terms of cellular subscribers and I see that as a solid achievement. We will continue to strengthen Cellcom Israel’s position as a leading communication group, providing comprehensive communication solutions to our customers. I believe that our strategy and the effort I just outlined will serve as an important base for the continued success of our group in the coming years.

In closing, I want to thank our employees and management for their efforts in 2012. I’m confident in their capabilities and determination in leading the company to success. As always, we are committed to continuing our efforts for the benefit of our customers, shareholders and dedicated employees.

With that, I would like to turn the call over to our CFO, Mr. Yaacov Heen, for a review of our financials. Yaacov?

Yaacov Heen

Thank you, Nir, and good day to all of you. 2012 was a challenging year for the communications market and for the company. While we’ll continue to implement efficiency measures in order to adjust the company’s expense structure to our revenue level, we expect further revenue erosion in the first quarter of 2013, which will lead to further erosion of profitability.

Now turning to our consolidated results. Please note that in 2011, we consolidated Netvision’s results for September through December 2011 only, following the completion of the acquisition of Netvision on August 31, 2011. While in 2012, we consolidated Netvision’s results for the full year, as well as the annual comparison to 2011 include Netvision’s results for September to December 2011 only.

Revenues for 2012 totaled ILS 5.94 billion decreasing by 8.7%. Within this, service revenues decreased by 3.7%, totaling ILS 4.58 billion and revenue from equipment decreased by 22.4%, totaling ILS 1.36 billion. Excluding Netvision’s contribution for 2012, revenues decreased by 20.2% totaling ILS 4.9 billion.

Revenues for the fourth quarter decreased by 15.5% totaling ILS 1.41 billion. Operating income for the year decreased by 30.7% totaling ILS 985 million. For the fourth quarter, operating income decreased by 7.8% totaling ILS 189 million.

In 2012, EBITDA declined by 19.1% totaling ILS 1.75 billion and net income for 2012 decreased by 35.6% totaling ILS 531 million. Excluding Netvision’s contribution, EBITDA declined by 29.5%, totaling ILS 1.47 billion. EBITDA for the fourth quarter of 2012 decreased by 12%, totaling ILS 374 million, while net income increased by 48.7% totaling ILS 113 million. This increase is the result of one-time adverse effect on the result of the fourth quarter of 2011, among them the one-time deferred tax expense recorded in the fourth quarter of 2011.

Turning to our KPIs. MOU for 2012 totaled 390 minutes, compared with 346 minutes in 2011, an increase of 12.7%. For the fourth quarter, MOU totaled 428 minutes compared with 351 minutes in the fourth quarter of 2011, an increase of 21.9%. ARPU for 2011 totaled ILS 87.5 compared with ILS 106 in 2011, a decline of 17.5%. ARPU for the fourth quarter totaled ILS 82.4 compared with ILS 95.4 in the fourth quarter last year, a decline of 13.6%.

In the fourth quarter of 2012, we generated free cash flow of ILS 288 million, a 188% increase compared with the fourth quarter of 2011. We concluded 2012 with a free cash flow of ILS 1.13 billion, a 20.6% increase compared with 2011, despite revenue erosion. The increase in free cash flow in 2012 is primarily the result of a decrease in equipment sales, which led to a decrease in our equipment purchases as well as the efficiency measures implemented during the year.

We are pleased to conclude the first full year of our merger with Netvision, which contributed ILS 1.05 billion to Cellcom revenues and ILS 283 million to our EBITDA.

Our net debt at the end of 2012 concludes with ILS 4.55 billion, a decrease of ILS 330 million, compared to year end 2011. The company’s board of directors decided not to distribute dividend for the fourth quarter of 2012 in order to further strengthen the company’s balance sheet at this time of market uncertainty. The board of directors will reevaluate its decision in the coming quarters as market condition develop and taking into consideration the company’s needs.

With that, I would like to open the call to questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator Instructions) The first question is from Gilad Alper of Excellence Nessuah. Please go ahead.

Gilad Alper – Excellence Nessuah

Hi. I have two questions. Firstly, can we – when is the earliest point where we can expect realistically that the market stabilizes and maybe even goes up a little bit? And the second question is that your head count in 2012 shrunk by about 25%. Can we expect a similar decline of 25% or so in 2013? Thanks.

Nir Sztern

Hi, Gilad. This is Nir. Thanks for your interesting questions. Obviously, regarding when and how the market will stabilize, it’s still early days. We’re still not sure of – as we mentioned in the earlier part of the conference, a lot of the prices are dictated by the market and especially by the new competitors in the market. I think we need to look forward to when and – they’ll reach their target point of 7% market share. I think that’s going to be an interesting point looking forward. Still, it doesn’t assure – doesn’t guarantee that prices will go – will change in any way at that point. But I think that’s the first important point for us to see whether and when the market will stabilize. Other than that, I think it’s fair to say that we don’t know.

Gilad Alper – Excellence Nessuah

Okay.

Nir Sztern

In regards to the total reduction of head count, we’ve done a lot this year, like I said 1,800. We’re still working and seeing how we can streamline our processes and as the market goes further and further into more simple plans and more bundled plans, then by default, we’ll need less of the head count to do that. I think 25% for 2013 is very ambitious. I’m not sure we can reach those numbers. But we are – we won’t stop the processes and work we do in the company to cut down our costs.

Gilad Alper – Excellence Nessuah

Okay. Thank you.

Operator

The next question is from Dov Rozenberg of Clal. Please go ahead.

Dov Rozenberg – Clal

Hi. Thank you. First question is on equipment. I was wondering if – the equipment was up this quarter, is there any sort of way to divide it out, maybe give a little color regarding if part of it was a boost from the IDF?

Nir Sztern

Most of the growth came from the launch of the iPhone. At the end of quarter, we launched the iPhone 5 and any new launch of an iPhone boosts the sales of handsets?

Dov Rozenberg – Clal

So the IDF still wasn’t a substantial impact here?

Nir Sztern

We are in the middle of the process to migrate the IDF, it’s the same as in the third quarter and we expect it to continue in the first quarter of 2013. That is and as said, the main impact regarding the equipment sale is as usual when a new model came to Israel, usually we expect and we see a significant increase in the handset sales.

Dov Rozenberg – Clal

Okay. Thanks. As far as ARPU, I was wondering if you – if there’s any breakdown you can give as far as, was there any sort of boost in comparison to the subscriber to the – cutting up the 138,000 machine-to-machine subscribers or is there any boost from Golan here. Is there anything else that’s sort of non-ongoing within the numbers?

Yaacov Heen

No. the impact of the machine-to-machine, we mentioned a number in PR, so you can calculate it. We decided to clean our database and we had this criterion of ILS 1 in doing the last six months. The contribution from Golan, we don’t give this number because of the – our agreement with Golan, we cannot disclose the number.

Dov Rozenberg – Clal

Okay. Last question, more general. Is there any way to sort of fight the competition aside from just lowering prices that you can – do you guys have going forward?

Nir Sztern

We’ll – we’re doing what we have been doing the last six months and doing it very successfully, it’s mainly by bundling services. That’s what we’ve done in the Cellcom Total, that’s what we’re doing right now with the Cellcom Total for couples. We give value to the customer by offering more services at good price. And thus, we are competing head to head in terms of pricing.

The other thing is, relative to some of the new competitors that is in the market, we continue to offer great customer service which some of them don’t offer. So the combination of the two, we believe can allow Cellcom to, over time, not fight at the lowest numbers that are in the market, and I think we’ve proven that in the last quarter.

Dov Rozenberg – Clal

Okay. Thanks. One last question if I may. Just one on CapEx going into 2013. Should it be similar to this year or higher and does that include, do your estimates include LTE report generation or the deployment?

Nir Sztern

We expect that we can keep this level of investment even lower. For the next year, of course, we don’t know about the tender if the government asks some fees for that, but excluding these costs, we can keep even a lower investment for the next year.

Dov Rozenberg – Clal

Okay. Thank you very much.

Operator

The next question is from Alex Balakhnin of Goldman Sachs. Please go ahead.

Alexander Balakhnin – Goldman Sachs

Yes. Good afternoon. I just wanted to ask you, in terms of your cost-cutting initiatives, if revenues keep declining in 2013, do you think you will be able to upset a big part of that or do you think you’ve gone quite a long way with the cost optimization, so your margin will also contract? Thank you.

Nir Sztern

Well, as I mentioned earlier, we will continue the efforts towards cost cutting. Some of the things that we’ve done in 2012, we’ll see the result of them in 2013, things like rents and closing down of shops that we closed in 2012, we’ll see the rent going down only in 2013. So, you – we will see some of these things come into 2014 and the next year. Other than that, we will – as I said, we will continue a lot of the cost cutting. I think it’s fair to say that, I mean the revenues will probably go down faster than we’ll be able to cut the costs as we had in the last year. Whether or not and how much of the revenues we’ll be able to cover with the cost cutting, I think it’s still early days to say.

Alexander Balakhnin – Goldman Sachs

Okay. Thank you.

Operator

The next question is from Louis DiPalma of William Blair. Please go ahead.

Louie DiPalma – William Blair

Good morning. This is Louie DiPalma, representing Jim Breen. How are you guys?

Nir Sztern

Thank you.

Louie DiPalma – William Blair

Earlier, you guys commented that the new entrants are targeting a 7% market share. Do you guys know what market share that they currently are at right now?

Yaacov Heen

Our assumption in the market, because the government published a note about it, that it expects the total market to be around 5 million customers, the private sector. So, if you look at HOT numbers, it seems that they are very close to this numbers, that’s the assumption in the market.

Nir Sztern

I mean, we obviously, don’t know their numbers and we can’t comment on their – whether or not they will reach the numbers, but there have been a few publications in the last few weeks, (inaudible) like Yaacov said, let’s say, in the quarter are probably near and Golan are getting there. But you can look at the publications in the last week and read it there.

Louie DiPalma – William Blair

Okay. And in terms of subscriber trends, was there, besides price, were there any particular reasons why net losses accelerated in the fourth quarter relative to the third quarter?

Nir Sztern

Yes. It’s only, I mean, the market is under fierce competition, prices are going down and subscribers are switching between the companies. That’s what’s driving the change in the customer base.

Louie DiPalma – William Blair

Okay. And are there any further opportunities to engage in bundling with wireless and Netvision in order to combat that price competition?

Nir Sztern

We’re doing a lot already. We’re negotiating with Bezeq and HOT in terms of the wholesale market. Hopefully, that will also will enable us to do more bundling, but things are going there pretty slow. So we won’t see any new – I think new news from that area in terms of wholesale in the next few months. Most of the bundles right now that we do include most of the communication services. We bundle the cellular service, the ISP, the international long distance calls and the fixed line, the home telephony. So, we’re already at a point that we offer a lot of the services. When we talk about the business customers there, we bundle a lot more services, we – as security, we do data centers and we bundle all these and many more services and we try to bundle some of these services along with the cellular as well.

Louie DiPalma – William Blair

Approximately what percentage of your wireless subscriber base is on bundles with Netvision or other wireline services?

Nir Sztern

We don’t give this number out. Sorry.

Louie DiPalma – William Blair

Okay. Thanks a lot guys.

Nir Sztern

Sure, thanks.

Operator

The next question is from Nicole Gilliat of Ion Asset Management. Please go ahead.

Nicole Gilliat – Ion Asset Management

Hi, good afternoon. My question regards CapEx, on your third quarter call you guided for CapEx for 2012 to be around ILS 500 million and then lower – around or lower that figure for 2013. So I was a bit surprised when CapEx came out to ILS 537 million. Could you explain the jump in CapEx in the fourth quarter and if we should continue to see CapEx around or lower than ILS 500 million in 2013?

Yaacov Heen

First, we said that we expect the CapEx of 2012 to be lower than the level of ILS 600 million consolidated company Netvision and Cellcom in 2011. So we are significantly lower, more than ILS 70 million lower. So in this case we are in line with our plan.

We decided of course to continue to improve our coverage and our capacity to our customers because this is very important right now that the customer use more and more the smartphone, so we decided to take this opportunity. And in the second half of 2012, we invest more in our core network and in our backhaul. So this is roughly in the ILS 500 million – ILS 537 million, this is the right number. But we never give up for an opportunity to improve our network. In other area like in the IT and in the service centers or other, let’s say, non-profitable like in the core network, we invest less. And as I said before, we expect that we can live with this level even lower for 2013.

Nicole Gilliat – Ion Asset Management

Thank you.

Operator

(Operator instructions) The next question is from Ari Cohen. Please go ahead.

Unidentified Analyst

Hi, guys. I would like to ask you a couple of questions. I’ll begin with the first one. Orange claims to be the first to declare its LTE service. Are you ready to market this service at the same time?

Nir Sztern

Well, I don’t know what Orange is saying. I mean – still the issue of LTE is still in – at the Ministry of Communications. There – sometime maybe this year or maybe later, will be a tender for newer frequencies, until then, it’s early to say when and who will be first. I don’t think it’s responsible to even talk about it at this point.

Unidentified Analyst

Can you give us estimates, the numbers of investments you can expect for building this LTE?

Nir Sztern

Not at this time. I’m sorry, no.

Unidentified Analyst

Okay. Another question is in the third quarter, the MOU up 399 minutes. In the fourth we can see increased to 428. Is there any effects on the cost of revenues and if yes, what is the effects by percentage?

Yaacov Heen

The increase is – of course there is an impact regarding the costs, because we have to pay the interconnect to our competitor, but it’s the same in the incoming revenues. So, the reason impact both in the revenues as well as in the costs.

Unidentified Analyst

Okay.

Yaacov Heen

The new market that most of the customer – or at least the new customer are using more and more the unlimited package, so the volume is higher, the incoming calls and the outgoing calls.

Unidentified Analyst

Okay. Netvision service income in fourth quarter was ILS 239 million and compared to ILS 291 million in the third quarter. Is it – can you tell us if it’s a seasonal decrease or a result of the growth in competition?

Nir Sztern

Again, you’re talking about what...?

Unidentified Analyst

Comparing to fourth to third quarters of...

Yaacov Heen

No. Usually the seasonality because of the roaming revenues which is the highest quarter is the third quarter, so this is one impact and the second of course the continuous price erosion which continue to affect our service revenues.

Unidentified Analyst

I’m speaking about Netvision income?

Yaacov Heen

The Netvision income is affected by the long distance a little bit and the other services, not something that is a dramatic change in the revenues.

Unidentified Analyst

Okay. Another question is, most of the market gives unlimited international calls up to 53 countries, some of them even to mobile as a basic part of unlimited package. Can you see any effect of (inaudible) revenues in Netvision income from international calls?

Nir Sztern

The impact is – we can see an impact, but the global trend or the local trend that we have in Israel, it’s a decrease in the long distance calls. So, we compensate part of it by this Total offer, that we offer our customers, the long distance included in the package.

Unidentified Analyst

Okay. Thank you.

Operator

The next question is from Lindsay Earl. Please go ahead.

Lindsay Earl

Hello. My question is, as we look at 2013, does – is there any hope that there will be a dividend paid again in 2013? We’re not receiving it at this time.

Yaacov Heen

As we said and we wrote it in the PR, it’s board of directors decision and as long as the uncertainty in the market is there, we believe that it’s right for the company as well as for our investor to decrease the dividend and to strengthen our balance sheet to decrease also the interest cost. And then, when we can see a more stable situation, the board of directors will probably reevaluate its decision.

Lindsay Earl

So, there is no assurance at this point there would be a dividend at this – in 2013.

Yaacov Heen

The board of directors will reevaluate the decision every quarter in 2013.

Lindsay Earl

Thank you.

Operator

There are no further questions at this time. Mr. Sztern, would you like to make your concluding statement?

Nir Sztern

Yes. Thank you. I want to thank everybody for joining Cellcom Israel’s fourth quarter and full year 2012 earnings conference call. As always, I look forward to hosting you again at our next call. Have a good day.

Operator

Thank you. This concludes the Cellcom Israel Ltd. fourth quarter 2012 results conference call. Thank you for your participation. You may go ahead and disconnect.

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