Cellcom Israel Ltd. Q3 2009 Earnings Call Transcript

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 |  About: Cellcom Israel, Ltd. (CEL)
by: SA Transcripts

Operator

Welcome to the Cellcom Israel Ltd. third quarter 2009 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 November 16, 2009.

I would now like to hand over the call to Ms. Fiona Darmon of CCGK Investor Relations. Ms. Darmon, would you like to begin?

Fiona Darmon

Thank you, operator. I would like to welcome you all to conference call and thank Cellcom Israel’s management for hosting the call today.

With us on the call is Mr. Amos Shapira, CEO and Mr. Yaacov Heen, CFO. Mr. Shapira will open the call by providing a summary of the main highlights of the quarter, followed by Mr. Heen, who will review Cellcom Israel’s financial performance in more detail.

Before I turn the call over to Mr. Shapira, 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 company 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 Israeli Securities Laws, 1968.

Actual results may differ from those discussed today, and, therefore, we refer you to a more detailed discussion of the 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, 2008, 20-F filed with the SEC.

In addition, any projections as to the company’s future performance represent management’s estimates as of today, November 16, 2009. Cellcom Israel assumes no obligation to update these projections in the future as market conditions change. You should by now have received a copy of the company’s press release. If you have not received so, please call CCGK Investor Relations at 1646-797-2868.

I would now like to hand over the call to Mr. Shapira.

Amos Shapira

Thank you, Fiona. Good day, everyone, and welcome to our third quarter earnings call. The third quarter of 2009 was a quarter of new financial records for Cellcom Israel, a noteworthy feat in the current environment. Our third quarter revenues, EBITDA and operating income all reached new highs, driven by our growing content and value-added services, landline revenues and tight cost management, enabling us to totally offset the macroeconomic impact on our roaming revenues.

These strong financial results, the highest in the local market, reaffirm once again, the proven success of our business strategy, namely to focus on our core competency, cellular communications while constantly identifying and introducing new complementary services that leverage our existing assets to drive revenue, growth and margin expansion.

The success of our focus strategy is clearly visible in our ongoing increasing content and value-added services revenues, one of our major growth drivers. Our content and value-added service revenues are now the highest in the local market, surpassing both our competitors, a major achievement if take into account that we were the last to introduce 3G services in Israel. Furthermore, our revenues from landline services to business customers also grew this quarter.

Both of these revenue growths have contributed leverage existing infrastructure, meeting our defined expansion requirement that complementary activities need to also be synergetic on a cost basis. These revenue drivers also enabled us to totally offset the substantial impact that the economic climate bore on our roaming revenues.

This quarter we continue to strengthen our position as Israel’s leading and largest cellular operator by adding an additional 31,000 net new subscribers ending the quarter with a total of 3.259 billion subscribers, again 3.259 billion subscribers. We remained committed to delivering premium content and value-added services, viewing this profitable and fast growing area as a key element of our strategy.

Furthermore, this quarter, we further increased our 3G subscriber base by adding 64,000 net new subscribers for a total of 941,000. Our 3G subscribers now represent 28.9% of our total subscriber base, up from 27.2% at the end of last quarter and we are constantly introducing new innovative and advanced handsets to support and to satisfy the needs of the lucrative and growing 3G customer base.

In addition to driving revenue growth, we also continue to tightly monitor expenses. This enabled our higher revenue to translate into even higher gross operating and net income margins. Furthermore, these efficiency measures enabled us to achieve a record EBITDA, the highest in our history.

Here at Cellcom Israel, we continue to grow revenues and drive efficiencies without compromising on service, transparency or customer trust. This is visible in the conclusions of the "Public Trust" organization’s report, which analyzed the complaint levels has determined that Cellcom Israel service levels and complaint treatment is the highest for the customer.

Our strong performance enabled us to once again generate a healthy free cash flow of NIS 454 million, NIS 286 million of which, I am pleased to note we are giving back to our shareholders in dividends. This brings our 12 months dividend yield to 10.5%.

As we look to the future, we continue to focus on our core competencies, in mobility to target the value-added growth drivers of the cellular business, by addressing the key trends of the ‘Always-On’, ‘Everywhere Consumer’. This dedicated focus on what we do best continues to prove itself quarter-after-quarter, as we continue to generate steady growth and we will continue to serve as our underlying growth strategy, moving ahead.

Furthermore, we are currently operating in a highly dynamic and changing competitive environment, with many changes in the peer companies. As such, we believe many interesting opportunities may arise, opportunities which we will address at the right moment.

I will like to turn over the call to our CFO, Mr. Yaacov Heen for a detailed review of our financials. Yaacov, congratulations on your first earnings call as CFO of the company.

Yaacov Heen

Thank you, Amos. It is a pleasure to be here. Now to the results. Revenues for the third quarter of 2009 increased 1.5% to NIS 1,675 million compared to NIS 1,650 million last year. This is mainly driven by a 0.9% increase in service revenues and 7.1% increase in handset and accessories' revenues.

The higher service revenue resulted from a 32.4% year-over-year increase in content and value-added services, including SMS, as well as higher landline revenues. Both of these totally offset the ongoing airtime price erosion, as well as the substantial decrease in roaming revenues, due to the decline in both inbound and outbound tourism.

Cost of revenues was NIS 856 million compared to NIS 852 million last year. This increase is mainly due to a one-time NIS 15 million provision resulting from our intention to negotiate a settlement of dispute with Israel Ministry of Communication regarding frequencies fees pending in the Israeli Supreme Court.

SG&A expenses for the third quarter of 2009 totaled NIS 351 million down from NIS 352 million last year. This is mainly due to the lower advertising expenses. This was partially offset by higher deferred sales commission amortization expenses, as well as higher doubtful accounts and bad debt provisions, due to among others, number portability and economic climate. Operating income for the third quarter 2009 increased 5.4% to a record NIS 468 million compared to NIS 444 million last year.

EBITDA for the third quarter of 2009 increased to a record of NIS 655 million over last year. EBITDA for the third quarter excluding the frequencies fees provision rose 2.6% over last year to NIS 670 million. EBITDA as a percent of revenues totaled 39.1%, while EBITDA margin excluding this provision neared 40%. EBITDA margin in the third quarter of last year was 39.6%.

Financing expenses net for the third quarter of 2009 totaled NIS 122 million compared to NIS 109 million last year. The higher expenses resulted mainly from the higher debt level which [too] increased interest expenses, as well as higher CPI linkage expenses. This was partially offset by an income on foreign currency differences.

But even expenses were lower this quarter totaling NIS 57 million. This is mainly due to the future gradual reduction of the corporate tax rate from 25% in 2010 to 18% in 2016. This resulted in a one-time reduction of our deferred tax liabilities recognizing a NIS 41 million tax income.

Net income for the third quarter increased 19.4% to NIS 289 million or NIS 2.94 per share, compared to NIS 242 million or NIS 2.48 per share last year. Net income excluding both the provision under cost of revenues and one-time tax income rose 7% compared to last year.

Turning to our cash flow and balance sheet. Free cash flow for the third quarter totaled NIS 454 million, compared to NIS 480 million last year. Free cash flow includes NIS 124 million invested in company's current securities portfolio.

During the quarter, we invested NIS 156 million in fixed and intangible assets, compared to NIS 166 million last year. Shareholders' equity as of September 30, 2009 amounted to NIS 389 million, primarily consisting of accumulated undistributed retained earnings.

Now to our KPI; the churn rate in the third quarter totaled 4.9%, compared to 4.4% last year. The churn constitutes primarily of lower contribution prepaid subscribers and subscribers with collection problems.

Average monthly subscriber minutes of use rose to 338.1 minutes this quarter, compared to 336.3 minutes last year. Monthly average revenue per user, ARPU totaled NIS 150.4 compared to NIS 154.3 last year among others due to the lower roaming revenues.

Moving on to our dividend. Our Board of Directors declared a dividend of NIS 2.9 per share or a total of NIS 286 million, representing approximately 99% of our net income for the third quarter of 2009. As mentioned in the past, our dividend payments are not guaranteed and our board of directors should decide every quarter, it is absolute digression. Now back to you Amos.

Amos Shapira

Thank you. All in all, this has been a record quarter on the financial front, as we continue to increase and improve our customer base both in higher returned 3G customers as well as postpaid customers. There are many opportunities emerging in the current environment and we are constantly reviewing them, as part of our ongoing growth strategy.

With that, we would be happy to open the call to questions.

Question-and-Answer Session

(Operator Instructions). The first question is from Tom Ehrlich of RBC Capital Markets. Please go ahead.

Tom Ehrlich - RBC Capital Markets

Hi, Amos and Yaacov, congratulations on another good and steady quarter of performance. I have a few questions. The first one is, can you provide us with a little bit more color on what you're seeing in the demand for value-added and the data services. Is it coming from value-added services, data cards, a mix of both, and how do you see this evolve going forward? Can you also comment on a sequential basis on how roaming trends have been evolving, has it stabilized or are we seeing some uptick here?

Amos Shapira

So as to the past, where from the growth is coming of the value-added services or the content and SMS or what we call internally, (inaudible) voice revenues. So generally speaking, I can't put my finger on one item that created the growth; unfortunately, no killer application. It comprised all the kind of applications and uses starting first of all from music where we were the first in Israel to develop the music download to the cellular phone.

By the way, it is interesting to know that this year according to a publication that was unveiled in Israel that revenues or income of artist from downloads to the cellular this year were higher than income from sales of music disks. So this is very interesting.

Now we see also growth of video. We initiated this year some production of video programs, the first in Israel, which this business say that we enter to be producers of cellular programs, but it does say that as we did some years ago with music that we produced some music singles with singers in order to warm up the market, to increase the awareness of the ecosystem to the growing target, the target as I would say which is the content, the mobile content, this is what we are doing today with video.

Now this is another growing use. We see also every application on every use that leverage the advantages of the mobile phone like the GPS and information that leveraging the advantage of the cellular which is well known. Now so this is combined from all these applications. Now if you ask what about the future?

Now, first of all, you are well aware that I am not allowed to give any forecast for the future. The only thing that I can say is until now our success was that we succeeded to maintain the growth rate of our content and SMS, growth above 30% and by the way as we mentioned, our content and SMS revenue are the highest in Israel, although, we are the company with the lowest number of 3G subscribers. So it then indicates our potential I can say, there the number is there.

Now tomorrow, we are running a conference, which we call Cellcom Media, with all the players in the Israeli market in order to increase the awareness to what I called, the “New Tiger”, the media in the mobile media and what we say to all these players is that of course in order the players in the ecosystem, which are the mobile operators, the handset manufacturers, they are all players in the media, in the internet media, like Google and other internet sites, we all will fight in order to take a bigger share in the developing pie.

This is including also us the mobile operator, which we shall do our utmost in order to develop our advantage as the mobile operator, which is, our knowhow, our knowledge of the consumer, our constant and continuous connection to the consumer, the payment mechanism that we have with the consumer. We don’t need PayPal on the mobile phone in order to have quick sales. These are our advantages.

Of course the other players have their own advantage. What, the message that we are coming to tomorrow in the conference is, let’s increase the pie, in order that although we should compete with each other about the share of the pie, still let’s work together in order to increase the pie. This is the message, the best message that I can give you, although probably you would like to have a more concrete information which I, unfortunately I can’t tell you. I just give you the color as you ask.

Tom Ehrlich - RBC Capital Markets

Thanks Amos. This has been helpful. Can you just briefly comment on the roaming trends that you are seeing quarter-over-quarter, are you seeing some stabilization or resumed growth there?

Amos Shapria

Now I’ll let Yaacov to refer to this.

Yaacov Heen

The roaming revenue in the third quarter is seasonally much higher than the other quarters. So in absolute numbers, the decrease is higher than in previous quarter. But if you look at the trends of the tourism the decrease is lower as you can see the report according to the Ministry of Tourism. So, we see a change in the tourism. But the revenue in the third quarter is more impacted than in other quarters.

Amos Shapira

Now of course what Yaacov meant to say is that since the third quarter is a season of tourism, yes, so if there was an impact, of course when you have bigger pie, then in absolute numbers the impact is bigger although not all the impact is generated by the decreasing tourism. Part of it is of course the competition and things like that. But yes, this is something I would say that the trend of decreasing in the third quarter at least was not higher than it was in previous quarters.

Tom Ehrlich - RBC Capital Markets

Thanks guys and I’m looking forward to seeing you tomorrow on your Media Day.

Operator

The question is from David Kaplan of Barclays Capital. Please go ahead.

David Kaplan - Barclays Capital

Just if you can Amos, why you didn’t touch on the iPhone at all and I know the iPhone or we expect the iPhone to be introduced at some point in the relatively near future. Can you tell us where that is stuck right now and when you expect the Cellcom to be launching its iPhone?

Amos Shapira

Now we haven’t referred to iPhone because this is in the future and we can’t say anything about the future. So, I'm sorry, but this is the best that I can say. The launch…

David Kaplan - Barclays Capital

Can you tell us in the present where the iPhone, where conceptually it lies right now. Is it still in, stuck with regulatory? Is it in the hands of Apple right now? Is it solely in the hands of Cellcom, can you tell us that?

Amos Shapira

I can say nothing about this issue because the only thing that can send you is to read in the news, in the media, but I'm not allowed to give you any information about iPhone. It doesn’t depend on us. It depends on Apple and I'm not an official representative of Apple. So, the only thing that I can say is when it is launched in the future, probably it will be launched by all three players together.

David Kaplan - Barclays Capital

Okay, you did touch on your call about the potential for acquisitions in the market. Can you just explain a little bit about what you mean, what types of acquisitions you're talking about, maybe if not specifics then generally which areas of communications market you're referring to?

Amos Shapira

I'm not quite aware to that I address to acquisition. What I said is that I referred to opportunities, since we are talking about communication market which is very dynamic. What we wanted to transfer the message to you is that what we are doing all the time is that we learned, we examine the changes in the market and then we try to learn, where are the threats, and where are the opportunities.

As I say, as its happened in the past, that we thought that entry to the landline telephony to the business segment was a profitable and useful step, while we made a decision not to enter to the landline telephony and ISP to the private sector, because of the just simple analysis of whether this entry might we profitable or not and we thought that it is not the right move to make it. So, just an example that we examine all the time, what are the opportunities, where to enter, where not to enter and then we make decision every time accordingly.

David Kaplan - Barclays Capital

Is it fair to understand your use of the word tiger to describe a certain level of aggressive or aggressiveness in the telecom market vis-à-vis looking for and going after new opportunities?

Amos Shapira

Can you ask the question again?

David Kaplan - Barclays Capital

You keep using the word or the imagery of the animal tiger, which is an aggressive animal and if we look at Cellcom vis-à-vis what its competitors have done over I would the last 18 months, it doesn't seem as though Cellcom has been very aggressive. That’s not to say that Cellcom has not produced based in the businesses in which it is strong. But it has not clearly gone after new opportunities and it has clearly not expanded into new businesses.

So, when you say that Cellcom and again you and management keep referring to the word tiger which is the only reason I am using it for lack of a better word. How does that come to play in how Cellcom is approaching the competitive nature of the communications market in Israel?

Amos Shapira

First of all, I referred to the tiger, when I talked about the New Tiger which is the content market. Yes, with the development of this segment of the market and not to Cellcom. But if you refer to Cellcom, when I say, not necessarily tiger is a stupid animal. What we are saying is that if we examine our performance and growth in the last three years, our revenue growth in the last three years so you will see that in 2006 we were the second in services revenues and today in three years, the gap between Cellcom and the second player increased dramatically as you can see.

So yes, we are not a Chinese tiger or South Korean. But let’s say in our market, when you say yes we don’t jump on every opportunity just to say that we are innovative or something like that when we don’t see an opportunity to make a business. But if you look at our performance in growth of our revenues in the last three years and especially in 2009, and in our profit, yes I would say that at least in performance, we were aggressive.

Operator

The next question is from Anupam Palit of Jefferies Capital. Please go ahead.

Anupam Palit - Jefferies Capital

I had a couple of questions on the landline side of the business. I mean you talked about how it’s positively contributing to the overall revenue. Can you give us a sense of how the landline opportunity is growing compared to the core cellular business and what kind of a contribution it’s making there?

Secondly still on the landline side of things, presumably you are taking some share there from the incumbent, from Bezeq. What kind of a competitive response are you getting from Bezeq? Are they kind of trying to retain their customers through pricing discounts or is there any other kind of retention tool that they're using?

Amos Shapira

Since we haven’t given any information about the size or concrete information about the landline so I can't give you more than that. But the only thing that I can say is that the landline is not a business of billions. Yes, by the way, otherwise probably I would have to give you the full information. But I would say that landline is significant in the context of the non-voice revenues, which added to our growth potential. This is and the good thing in landline is that we are not forced to give a universal service.

So the advantage that we have is that we can make a cherry pick, of customer, where we think that it’s profitable to enter and customers that we do think that our profitable to enter, then we do not enter. So this is the best that I can give you that we do it in a very careful manner that not to waste our investments, and budget and only to make investment that give a reasonable return on investment.

This you can see it in our bottom line that probably it seems that we are doing to it wisely, and without any significant if at all additional expenses. We for the landline telephony to the business segments, we almost haven’t added any additional cost in order to develop this because this is the nature of synergy in order to put in more revenue on the same cost base. So, I wouldn’t say that we haven’t made any zero firm and more expenses, but I would say that they are most significant in any matter.

Anupam Palit - Jefferies Capital

Just a follow-up, if we can switch side back to the cellular side, you've got a very, very, data quarter, it’s going very strongly, expecting some new devices potentially to come in later this year, earlier next year and so the data contribution should grow over time.

Can you talk to us also about how much [enough] capacity you have available, are you going have to make some new investments in the network and potentially take some spectrum auctions in order to be handled all the incremental data? Thanks.

Amos Shapira

The only thing that I can say is that we are going to keep with our guidance that our investment will be below 10%, and at the moment we have enough capacity, and even if we have in the future so it will be the current investment in order to increase our capacity. In any case, what we are doing all the time and we say, hey we can achieve, we can get more revenue.

Yes, and we need in order to get these revenue, we need to invest this and that. So, we made a calculation. We made the calculation. We say we want this additional revenue or we don’t want this additional, but this is enormous practice not only to the data, but also in any respect.

Operator

The next question is a follow-up question from Tom Ehrlich of RBC Capital Markets. Please go ahead.

Tom Ehrlich - RBC Capital Markets

Just a few follow-ups here. First of all, on the tax rate, I understand that you had some one-time adjustments, what should we be looking for next quarter before the effective rate drop to 25%? Is there a chance you’re going to see more of those one-time as a head?

Yaacov Heen

Just one time net, let's say tax income due to the low and we have to do it according to the financial rules. It's something that happened just this quarter. We have to estimate the changes between the tax income according to the financial reports and it's just one-time. If there is no other change from the government, we will see the same numbers as we have the quarter before above 26% of the total net income and for the next year, 25 and so on.

Tom Ehrlich - RBC Capital Markets

Maybe just one more housekeeping question. I thought gross ads were up sequentially and also the number of 3G additions but still seemed that equipment revenues were flattish to slightly down, any way to consolidate this?

Yaacov Heen

Can you say again the question please?

Tom Ehrlich - RBC Capital Markets

Sure. When we look to the second quarter over the third quarter of 2009, you had a high gross addition number and higher 3G addition number and equipment revenues were a bit lower on a sequential basis. Anything happening there or is it only marginal?

Yaacov Heen

It’s a mix and you know that generally we reduce the subsidies, so the prices of the new handset relatively to previously are higher, and that’s why the subsidy is lower.

Operator

(Operator Instructions). The next question is from Anil Doradla from William Blair. Please go ahead.

Brian Nugent - William Blair

Hi, it's Brian Nugent in for Anil. Real quick just on the seasonality, you did talk about how that might impact your roaming minutes for the third quarter, but as we go into the fourth quarter, can you just talk about some of the other ways that seasonality will impact the P&L and how that might be different from last year given the holiday timing?

Amos Shapira

Traditionally, the third quarter is the best quarter in revenue because in [some area no daylight]. So I don’t see there is a difference in the seasonality for the coming quarter. There is a slight difference because of the timing of the festivals and Jewish holiday is between the third quarter and fourth quarter on favor of the fourth quarter, but it's just not significant.

Brian Nugent - William Blair

So you did mention that with tourism being down that’s a key part of the roaming, but you also mentioned competition, I am just wondering if there is anyway to sort of directionally has that competition for roaming minutes intensified or is it moderating in the last couple of quarters? Then, is there anyway to help us reconcile how much of the decline in roaming is due to competition versus tourism being down?

Amos Shapira

Now as I said, you all can read newspapers because tourism is affected by both the economic situation in the world and also in the political situation in Israel, and as probably you all remember previously, I was the CEO of an airline. So, the last thing that I would try to predict is what will be the tourism in the coming quarter or the coming year because these are so fragile. So, any forecast will be worthless.

Brian Nugent - William Blair

Right, but in the last couple of quarters have you seen the competition in terms of pie or is it more a reflection of the tourism?

Amos Shapira

Probably I wouldn’t say that I see intensifying competition. The only thing that I say is that the economy situation and the political situation is a little bit more favor or more relaxed, but we need more time in order to give more solid picture.

Brian Nugent - William Blair

Okay. Thanks a lot guys.

Amos Shapira

So that, I can give you a better picture.

Operator

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

Amos Shapira

Thank you everybody for joining Cellcom Israel’s third quarter 2009 earnings conference call. I look forward to hosting you again at our next call. Good day and happy holidays to all of us, whether it’s Hanukkah, Christmas, whatsoever.

Operator

Thank you. This concludes the Cellcom Israel Limited third quarter 2009 results conference call. Thank you for your participation. You may go ahead and disconnect.

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