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Cellcom Israel, Ltd. (NYSE:CEL)

Q1 2014 Earnings Conference Call

May 14, 2014 09:00 AM ET

Executives

Ehud Helft - Managing Partner, GK Investor & Public Relations

Nir Sztern - CEO

Shlomi Fruhling - CFO

Analysts

Gilad Alper - Excellence

Michael Klahr - Citibank

Alex Balakhnin - Goldman Sachs

Chris Reimer - Barclays Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Cellcom's First Quarter 2014 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. As a reminder, this conference is being recorded.

You should have all received by now the Company's press release. If you have not received it please contact Cellcom's investor relations team at GK Investor Relations or view it in the news section of the Company's website www.cellcom.co.il.

I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin, please?

Ehud Helft

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

With us on the line are Mr. Nir Sztern, the CEO and Mr. Shlomi Fruhling, the CFO. Mr. Sztern will open by providing a summary of the main highlights of the first quarter 2014 results, followed by Mr. Fruhling, 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 prepared remarks may contain forward-looking statements, which are subject to risks and uncertainties and management may take -- may make additional forward-looking statements in response to your questions. Therefore, the Company claims the protection of the Safe Harbor for forward-looking statement that is contained in the Private Securities Litigation Reform Act of 1995 and in the Israeli Securities Laws of 1968.

I note that actual results may differ from those discussed today and therefore, we refer you to more detailed discussion of the risks and uncertainties in the Company's filing with Securities and Exchange Commission, including under Risk Factors in the Company's annual report for the year ended December 31, 2013 filed under Form 20-F on March 6, 2014.

In addition, any projection as for the Company's future performance will represent management estimate as of today May 14, 2014. Cellcom Israel assumes no obligation to update these projections in the future if market conditions change.

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

Nir Sztern

Thank you, Ehud. Good day to all and welcome to our first quarter 2014 earnings conference call. We are pleased with the strong improvement in profitability that we have demonstrated in the first quarter of ‘14. EBITDA grew by over 8% from the first quarter of the last year to NIS340 million. We also increased the EBITDA margin from 25% to 30%. Operation income increased by 33% to NIS185 million and net income increased by 70% to NIS114 million for the quarter.

We more than doubled our free cash flow to NIS366 million. Over the past year we have used our free cash flow to lower our debt level by NIS1 billion and our net debt now stands at NIS3.6 billion. This represents a net debt to EBITDA ratio of around 2.65.

Most impressive is that we achieved all this despite the backdrop of tough competition and price erosion in the federal market which has continued into 2014 and lowered our revenues by 10% compared with the same quarter last year. We expect the price erosion in high competition the market to continue in the coming quarters and negatively affect our results.

Our success in improving profitability is due to our strategy of keeping a tight control over [indiscernible] and maintaining efficient operations. At the same time, we’re expanding our basket of products and services and maintaining our commitment to the provision of high quality service to all our customers.

This has enabled us to increase the customer base to which we sell packages of telecommunication services. In this quarter we saw an increase in postpaid subscriber, alongside a seasonal increase in prepaid subscriber churn that led to a net decrease of 43,000 subscribers.

The growth in postpaid customer base solidifies our position as the largest cellular company in Israel. All this helped us in mitigating the impact that the competition has had on our revenue erosion.

Over the past two years we’ve undergone a complete turnaround in our cost structure. We have reduced headcount substantially, load overhead expenses and streamlined much of our work processes. These measures have enabled us to reach cost saving at an annual runrate of approximately NIS820 million when comparing to the first quarter of 2014 expenses to those of the fourth quarter of 2011.

In the first quarter of this year we presented actual savings of NIS52 million in selling, marketing, general and administrative expensescompared with the first quarter of last year. As we moved through 2014, we're much a linear and more efficient Company than we have ever been in our history.

We expect the price erosion and the hike of addition to continue in the coming quarters, while our ability to continue implementing efficiency measures to mitigate the decrease in revenues will be reduced.

While continuing our ongoing focus on efficiency, we’re also investing in our future. A few weeks ago we announced the selection of Nokia Solutionsand network as a supplierof our 4G network. This network also supports LTE advanced technology also known as 4.5 generation technology, which will allow the company to be among the first operators in the world to launch such, such an advanced technology.

We have commenced roughly deployment of the network with the aim of providing our customers with a broad and high quality of coverage. I do know though that the operation of the network as well as its LTE advanced qualities is still subject to the regulators’ approvals and the availability of spectrum.

The Israel Ministry of Communication is soon expected to announce its decision as to development of fixed line wholesale market which will enable us to purchase the infrastructure all the way to the home. The establishment of an efficient wholesale market will allow us to strengthen our foothold in the fixed line market, a market currently worth about NIS4 billion and dominated only by two groups. We hope to expand our share in this market leveraging our existing fiber infrastructure, our customer base of over 3 million cellular subscribers and Netvision's household subscribers as well as our sales and customer support teams. We’re also considering entering the television market through over-the-top technology. The local television market is worth a further NIS3.8 billion and dominated by the same two groups which dominate the fixed line market.

The combination of an effective fixed line wholesale market with our leading position in the cellular market will enhance our ability to offer a full bundle suite of telecommunication services for the consumer. With regard to the pending decision by the regulator for the approval of network sharing, the regulators have not provided us with a formal decision yet and the parties are in active dialog aiming to determine a way forward in such a way that we can answer some of the regulators concern which will allow us to achieve our goals from these agreements, including material savings in operating expenses and capital expenditures, which will be mostly generated from the sharing of passive elements. We will update you on this once we receive the regulatory decisions.

In summary,while the competitive environment still remains tough for the all players in our market, we demonstrate high levels of margin and strong free cash flow for the first quarter of 2014.

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

Shlomi Fruhling

Thank you Nir and Ehud and good day to you also. As Nir mentioned, we are pleased with our results for the first quarter bringing the strong improvement [Technical Difficulty] activity across the board despite the cellular market which remains very competitive for all.

Despite the intense competition, we continued with our strategy of implementing efficiency measures wherever possible in order to adjust our expense structures to the revenue level. We improved our margin across the board with operation profit and net income margin at (16.5%) [ph] and 10.1% respectively versus 11% and 5.3% respectively for the first quarter of last year.

Our strong improvement in profitability, lower level of handset sales and efficient CapEx also enable us to conclude the quarter with a free cash flow of NIS366 million, an increase of NIS189 million over the last year. Our strong free cash flow allowed us to further strengthen our balance sheet in the quarter which I will get it in few minutes.

Turning to our consolidated results, revenue for the first quarter of 2014 totaled NIS1.13 billion decreasing by 10% from the first quarter of the last year. Due to continuing tough competition environment, the situation we expect will persist through 2014 and is expected to adversely affect our results.

Within this, our service revenues decreased by 5.9% totaling NIS927 million and revenue from equipment sales decreased by approximately 25% totaling NIS203 million. However all other financial target measures improved versus the first quarter of last year.

Operating income for the quarter increased by 33% totaling NIS185 million. As I mentioned, we have placed significant effort on reducing expenses as well as successfully reduce operating expense by 16% compared with those for the first quarter of the last year.

Our EBITDA margin significantly improved totaling 30.1% in the quarter versus 25% in the first quarter of 2013. We intend to continue our effort to improve efficiencies and reduce cost. However the next big step in cost cutting will come, we believe from network sharing agreement, if approved by regulators and implemented.

In the first quarter of 2014 EBITDA increased 8.3% totaling NIS340 million and net income for the first quarter increased by 70% totaling NIS114 million, up before the first quarter of 2014 totaled NIS74.7 compared with NIS75.9 in the first quarter of 2013.

As I mentioned, we conclude the first quarter of 2014 with a free cash flow of NIS366 million, 118% increase compared with the first quarter of 2013, despite revenue erosion.

We increased the free cash flow [indiscernible] as a result of the decrease in the payments to vendors for purchase of cellular handsets due to the lower level of handset sales and efficiency measures implemented during the year, deducting our operating expense and CapEx level. The building of the LTE networks is expected to increase the company CapEx in 2014 compared with those in 2013.

In terms of the balance sheet, our net debt for the end of the first quarter amounted approximately NIS3.6 billion, a NIS1 billion decrease over the last year. This debt level will represent an EBITDA to net debt ratio of 2.65, down from 2.9 at the end of the first quarter of 2013.

The Company Board of Directors decide not to distribute a dividend for the first quarter of 2014 given the continued intensified competition in the market and the adverse effect of the Company’s revenue in order to continue using the free cash flow to strength the company balance sheet. The Board will continue to reevaluateits decision in the coming quarters as market conditions develop, while taking into consideration the Company’s needs.

With that, I will like to open the call to questions.

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. Please go ahead.

Gilad Alper - Excellence

Hey congratulations on the results. A couple of questions, the first one is, we’ve been seeing the erosion in Netvision revenue over the past three years. And I am assuming that once the wholesale market will start most likely somewhere in the beginning mid of the 2015, we’ll see a change. But how dramatic do you believe it will be? Will we see just the stability? Do your plans include a substantial increase in revenue? Where are we standing on that?

Nir Sztern

Well it’s hard to say right now, we’re still waiting for the MOC to finalize the pricing on the wholesale market. Once we see that, then we’ll be able to determine our go-to-market pricing and the margins and revenues that we can see from the market.

So we are -- I can say clearly with the results of measures but despite -- and we don’t talk about it usually, but we see a lot of competition also in the ISD market and despite the competition, we’re still maintaining profitability and our bottom lines and then in Netvision, and we’re differently expecting and hoping for good results from the wholesale decisions and we can see growth in revenues there as well.

Gilad Alper - Excellence

Okay, second question is regarding the working capital, so as you mentioned the high free cash flow is probably due to the working capital. How many additional (credits) do we -- should we anticipate to see this? What is the level of working capital that you see as a long-term?

Nir Sztern

It’s hard to say about the long-term, but we believe that we’re going to have another two quarters with a positive working capital and after it depends on the development of the market.

Operator

The next question is from Michael Klahr of Citibank. Please go ahead.

Michael Klahr - Citibank

Couple of questions from me, firstly on the good work you’ve done on cutting costs and you mentioned network sharing being the next opportunity there. Is there anything else that you can do through the end of the year before network sharing to reduce cost or this is what we should say is the cost base for going forward ahead of network sharing?

And the other two questions, one, what’s your best estimate for your launch into the fixed market post wholesale? Is it Q4, is it Q1? And then also what cost expense do you expect as a result from your launch into that market? Where should we see increases in costs and can you quantify that?

Nir Sztern

In terms of our -- the first question was, are we going to see more cost cutting other than the network sharing? The answer is yes, we’re focusing on that. The whole company is working all the time to cut cost. Obviously as time moves on, the ability to maintain the rate of cost cutting is lower, but we’re still working on it, we still see potential,we just announced yesterday for example that we are operating, upgrading our CRM systems.

So that for example is, for the long-term is another potential for cost savings. We have a newer, faster,with leaner processes CRM system that will allow us to cut some more costs. And we’re all the time working to see whether or not and how we can improve that.

In terms of the second question on wholesale on timing and impact on revenues, again, I’ll answer the same as I answered the first question. It really is out of our hands. We would love to see wholesale starting tomorrow. We don’t know when and how low or high the prices are going to be. So I think the safe bet is around the fourth or the first quarter, I don’t know, I can’t help you with that and again in terms of costs, it’s still early because some of the issues in the hearing are not closed yet, we’ll be smarter hopefully in a month or two.

Michael Klahr - Citibank

But do you -- I mean coming back to costs, I mean you’ve obviously got -- you’ve cut back on advertising expense in the last few quarters. You obviously going to have to launch a product in the market, so there is some associated costs, just trying to get a feel, we're talking few tens of millions of shekels or higher than that?

Nir Sztern

Well I mean we're launching new products, obviously there is cost associated with the launch of new product and entering a market. I am putting that aside, some of what we've seen in advertising is seasonal, so it’s nothing dramatic there.

And specifically talking about wholesale market, it’s a completely different ballgame and some of the costs are going to cost of buying the network from basically [indiscernible] others are going to be marketing, but we're going to see revenues there. I think once we see more details on wholesale pricing, we'll probably be able to answer your question with more detail.

Operator

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

Alex Balakhnin - Goldman Sachs

Yes, good afternoon. My question is on the profitability of the handset business and it seems that it improved quite nicely in the first quarter for the market. Can you please confirm that you see the trend and to what extent do you think this trend is sustainable?

And do you think that your competitors maybe or you maybe reinvesting some of the relief of the EBITDA coming from a more profitable sales of handsets into the bit pricing potential yet market share? Thank you.

Nir Sztern

Well, we don’t give the profitability of handsets so -- and I can’t answer what you said earlier. The only thing I can say about handset is that we're very much focused on that business and we're doing as we speak a lot of work in terms of advertising and adding new handsets and launch of new phones especially now in the second quarter and putting a lot of Company’s efforts and maintaining that as a strong business.

Alex Balakhnin - Goldman Sachs

May I probably just -- rephrase if I may, do you see the mix of the handsets you sell shifting towards the Cellcom branded handsets?

And that’s one, and second, would you describe the market environment in handset in the first quarter or say in the first half of this year as more benign that it’s used to be over the last several quarters?

Nir Sztern

Well, we don’t have branded handsets, so the mix has been the same. We see obviously over the last few years and that trend is still going on. A lot more smartphones and so that trend is just getting bigger. The environment, in terms of the environment of the handsets, we saw over the last two years, a lot of competition and independent shops opening everywhere in Israel that sell handsets. And we haven’t seen any change in that environment over the last quarter or two. So it’s pretty much a very similar quarter in terms of the handset market environment as it was in the last quarter or two.

Operator

(Operator Instructions) The next question is from David Kaplan of Barclays. Please go ahead.

Chris Reimer - Barclays Capital

Hi, this Chris Reimer on for David Kaplan. I wanted to ask, what you are doing about the 4G network seeing as the wholesale market is not going forward just as yet. You also mentioned increased CapEx spending for going to 2014 and can you elaborate a little bit on that?

Nir Sztern

Can you just repeat the first question on the 4G network? I couldn’t hear you. I am sorry.

Chris Reimer - Barclays Capital

Yes, what is the status of that now? You mentioned more CapEx throughout 2014, are you building out, are you on hold, how does that effect? How does waiting for the wholesale market to come available affect your CapEx spending now?

Nir Sztern

In terms of the 4G, as we mentioned, we signed an agreement with Nokia Solutions to buy LTE advanced network and we are in the process of rolling out the network right now as we speak, [indiscernible] are rolling out the network. When we launch it is dependent on when we get frequencies from the Ministry of Communication. So we're going there but we're actually working very hard to roll-out the network as fast as possible and that’s something that we're going to do. In terms of CapEx...

Shlomi Fruhling

Yes, we said that it will be a little bit higher than 2013, but it won’t be a significant change but in total -- our expense will be -- the total CapEx of the company will be a little bit higher than those in 2013.

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 would like to thank all of you for joining our conference call and your continued interest in our Company. I look forward to hosting you again at our next call. Have a good day.

Operator

Thank you. This concludes the Cellcom Israel Limited first quarter 2014 results conference call. Thank you for your participation. You may go ahead and disconnect.

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