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Cellcom Israel Ltd. (NYSE:CEL)

Q1 2010 Earnings Call

May 17, 2010 9:20 a.m. ET

Executives

Porat Saar - CCG, IR

Amos Shapira - CEO

Yaacov Heen - CFO

Analysts

Anupam Palit - Jefferies

David Kaplan - Barclays Capital

Tom Ehrlich - RBC Capital Markets

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Cellcom Israel Ltd. first quarter 2010 results conference call. All participants are 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 May 17, 2010.

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, operator. I would like to welcome you all to the conference call, and thank Cellcom Israel's management for hosting this call today. With us here are Mr. Amos Shapira, our CEO, and Mr. Yaacov Heen, CFO.

Mr. Shapira will open by providing a summary of the main highlights of the first quarter 2010, followed by Mr. Heen, who will review Cellcom Israel's financial performance in further 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 Law 1968.

Actual results may differ from those discussed today, and therefore we refer you to a more detailed discussion 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, 2009 20-F filled with the SEC.

In addition, any projections as to the company's future performance represent management's estimate as of today, May 17, 2010. 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 have not received so, please call CCG Investor Relations at 1-646-233-2161.

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

Amos Shapira

Thank you, Porat. Good day everyone, and welcome to our 2010 first quarter earnings. This has been a good quarter for Cellcom Israel, and we have demonstrated a strong EBITDA margin with sustained growth in service revenues' EBITDA, operating income, and our subscribers' base.

During this quarter, we have seen an improvement in the growth rate of airtime minutes, which totaled 4.8% in the first quarter this year, compared to 2.5% in the first quarter of last year. We have also seen growth in our service revenues, which totaled 3% this quarter, compared to 1.1% in the first quarter of last year.

Furthermore, we continue to expand our 3G subscriber's base reaching over 1 million subscribers at the end of March 2010. This now represents 31.3% of our total subscribers' base. We are pleased with our results, because as we all know, the Israeli cellular market is highly competitive and constantly evolving. Yet, we have continued to maintain our position as the cellular operator with an overall best financial performance, and as market leader in terms of subscribers' base, as well as in total revenues.

I believe this is a result of our strategy, which is to focus on cellular communications. At the same time, we are committed to delivering quality customer service. Also, we have been able to leverage our core business through synergetic growth opportunities, while prudently managing expenses. I think this further solidifies and supports our leading position and strong financial performance.

I am happy to announce that we recently finalized acquisition of the assets and operation of Dynamica, one of our major dealers. As part of the acquisition, Dynamica's communications chain store will continue its operations as a fully owned Cellcom Israel subsidiary.

I want to take this opportunity to welcome all Dynamica's managers and employees to Cellcom Israel's family. I look forward to working together in the future, so that we can continue to provide our subscribers with quality customer service and the most advanced products and handsets.

Finally, I would like to briefly touch upon the recent developments that have taken place here in Israel regarding the Ministry of Communications' plan to reduce interconnect fees in the cellular market. We have until the beginning of June to prepare a response. We intend to object to the decrease of interconnect tariffs as suggested, especially to the way it is implemented, which may have an adverse effect on the Company's results.

The Company intends to take measures to mitigate as much as possible the expected adverse effects of such proposed changes through revenue enhancement, as well as cost reduction.

In closing, we will continue to track and respond to the dynamic changes in the local communications market, and will continue to focus on our core business. We remain committed to providing the best services to our customers and will work to achieve strong financial results for the benefit of our shareholders.

We had a very positive first quarter, and I look forward to the rest of the year.

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

Yaacov Heen

Thank you, Amos. We are happy to report that we have kicked off 2010 with positive results. Our revenues for the first quarter of 2010 increased by 1.2%, totaling NIS 1.58 billion, and despite the ongoing airtime price erosion resulting from the market competition, service revenue increased by 3%, reaching NIS 1.4 billion.

Meanwhile, revenues from content and value-added services increased by 24%, making up 17.8% of our service revenues. Likewise, we have shown quarter-over-quarter growth in other key areas, including a 4.6% increase in operating income, reaching NIS 457 million for the first quarter of 2010.

Our EBITDA increased by 1.8%, reaching NIS 638 million, and our EBITDA margin reached 40.4%. Despite growth in these key performance indicators, represented a 9% decrease in net income, which is attributed to an increase in our financing expenses.

I will now touch upon our KPIs. Average MOU increased by 1.6%, totaling 328 minutes, compared to 323 minutes in the first quarter of 2009. ARPU for the first quarter was at NIS 139.1 compared to NIS 139.9 in Q1 of 2009.

Moving to our cash flow, we continue to show solid results. This quarter, we presented a strong free cash flow totaling to NIS 387 million. This enables us to distribute a dividend of approximately NIS 360 million, representing 115% of net income for the first quarter.

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

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Anupam Palit of Jefferies.

Anupam Palit - Jefferies

My first question is just about the churn in the subscriber characteristics in the quarter. Churn spiked up a little bit. I was just wondering, was there anything in particular that happened in the quarter that would lead to the upside in churn and what the company is doing about it?

And secondly, on a related matter, on the 3G subscribers, the adds were about 40,000, a little bit low than we've seen in the past. I was wondering, again, was there anything particular in the quarter that led to lower 3G subscriber add? And how do you expect this to kind of trend with the newer handsets coming into the market through the course of the year?

Yaacov Heen

About the churn rate, of course it's more than 5%, which is relatively high, but the main churn is coming from the prepaid segment. And our main target is to improve our customer base, so we look at the bottom line and we have more than 20,000 net adds, which most of them or all of them are post-paid subscriber.

So this is about our strategy to continue to improve the customer base. And because we have a major part in the market -- in the pre-paid subscribers, so this trend of churn in the pre-paid segment, we suffer more than the operator.

Anupam Palit - Jefferies

And on the expense side of things, some very good cost controls on the sales and marketing side, on the G&A side. Was there any specific cost initiative that you guys started at the beginning of the year, or is this just kind of regular cost containment that's taking place?

Yaacov Heen

There is nothing special about the costs. We continue with our strategy to control the cost structure, so this is the outcome of this --

Amos Shapira

Let me add something, which is, the nature maybe of our business is that as it comes to the expenses, it's very similar to what is going with our income. Our top-line is that there is no killer application, so this is valid also to our expenses. Unfortunately, we couldn't find something very big in order to reduce our costs.

It's actually comprised with many activities that altogether make our activity in lower cost. So this is a daily activity that we are running all the time.

Operator

The next question is from David Kaplan of Barclays Capital.

David Kaplan - Barclays Capital

If we can focus for a second on regulation, first of all we have the termination rate cuts that were announced by the Ministry of Communications. I know the companies are focusing now, and Cellcom in particular is focusing now on preparing its response to the ministry. Can you talk a little bit about what it was that the ministry had said, or how it got to the numbers that it did, and what differences you see?

Amos Shapira

We are now in the process of learning what the recommended decision, as the government represents it, and there is that rearing process. And as we wrote, and as I said, what we see now is that we'll give objection to their decision and also to the process, how it is done. And in the meantime in any case, we are not resting, and we are learning. We have already started to learn how we are going to respond in the marketplace if this decision would take place.

David Kaplan - Barclays Capital

And then I guess continuing on, you started talking a little bit about the pre-paid space. And I think if we take the termination rate cuts one step further, to some extent, I think what we're really looking at is the opening of the window for potential multiple MVNOs or virtual operators. Can you talk a little bit about where you see that market in particular going, especially when you look globally, you see how virtual operators have focused on the pre-paid market?

Can you talk a little bit about how you think you're going to deal with new competitors in the market, particularly in the pre-paid market, how that may or may not change your business? Will it cause you to focus on other areas where you've focused less in the past? And, of course, there's also the potential for MIRS to become a more active market participant as well? Can you talk a little bit about that?

Amos Shapira

I expressed my view many times. I don't believe that an MVNO has a reason to exist. And not because it doesn't matter really what will be the decision of the government and what will be the interconnect rate; I'm talking about the business case of MVNO. This is happening in most of the cases all over the world, and I believe that this will be the end result in Israel.

A business MVNO is a model that doesn't have a reason why; because if someone doesn't have any advantage, not in cost and not in the product itself, there is no reason that he will have success. Now, this is my view about the MVNO in general.

Of course, we prepare ourself, and I can guarantee you that when MVNO enters the market, if it happens, and no matter will be the intervention, whether it will take place, of the government. Now, even in the worse scenario, but I don't know whether it will take place, that the government will force us to send to MVNO. And even in the case that they will intervene in the crisis, then another option is open to Cellcom is to establish its own, let's say, different brand like this, and this is a possible strategy, and to sell to ourself in this process and to compete with any potential MVNO in this case.

So, this is a strategy that I made in other companies that I were, in different industries, because in a way, MVNO is private label in other markets. So I know very good how to deal with this case.

David Kaplan - Barclays Capital

All right then.

Amos Shapira

Hope that I was clear with it.

David Kaplan - Barclays Capital

Yes, thanks.

Amos Shapira

So I say, this is the extreme scenario, if takes place.

Operator

The next question is from Tom Ehrlich of RBC Capital Markets.

Tom Ehrlich - RBC Capital Markets

Hey guys, congrats on a good quarter here. Maybe a question about usage trends and what do you see out there in terms of roaming and the minutes of use and usage patterns of your subscribers, that's one question. And the second question is, if you can talk a little bit about your landline activities, where are they going, what's the status there? Any comment would be appreciated. Thanks.

Yaacov Heen

Okay. About the MOU, as you see in our result, we achieved a growth of 1.6%. The total minutes, it's about 5% growth which is higher than we saw last year. We don't know if we can describe now describe now a change in the market, but it's higher than we saw last year.

About the roaming, of course I think we saw a real impact and a decrease regarding the number of tariffs, both inbound roaming, outbound roaming. And this year, of course, it's not the same, and so we don't expect any other decrease in the roaming this year. And regarding the landline - Amos?

Amos Shapira

Regarding the landline, as I said many times, the scale of the business is such that we not change the scale of Cellcom's, yet when it comes in the generator or growth for the company to all the other activities like applications, content and all this, this is a significant activity, especially in our case, as we are active only in the business sector. Since in this sector, we have synergies with our current activities in difference with the private sector that we haven't entered to this sector because it requires additional cost that we believe don't have return to the investment.

So we are pleased, and it goes according what we plan, and this is part of the reason of the growth that we see in this quarter.

Operator

(Operator Instructions) 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 first quarter 2010 earnings conference call. I look forward to hosting you again at our next call. Good day.

Operator

Thank you. This concludes the Cellcom Israel Ltd. first quarter 2010 results conference call. Thank you for your participation. You may go ahead and disconnect.

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