Cellcom Israel Ltd. (NYSE:CEL)
Q2 2010 Earnings Call
August 26, 2010 9:30 pm ET
Porat Saar - CCG IR
Amos Shapira - CEO
Yaacov Heen - CFO
David Kaplan - Barclays Capital
Daniel Meron - RBC Capital Markets
Darren Shaw - UBS
Welcome to the Cellcom Israel Ltd. second quarter 2010 results conference call. (Operator Instructions)
I would now like to hand over the call to Ms. Porat Saar of CCG Investor Relations. Ms. Saar, would you like to begin?
I would like to welcome all of you 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 second 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 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, 2009 20-F filled with the SEC.
In addition, any projections as to the company's future performance represent management's estimates as of today, August 26, 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 yet 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?
Thank you, Porat. Good day everyone, and welcome to our 2010 second quarter earnings. This quarter, we presented strong performance with solid growth in revenues, EBITDA, EBITDA margin, operating income, net income and subscribers' base. Our airtime minutes grew 5.6% this quarter and our service revenues by 5.5% year-over-year. We also continue to expand our 3G subscriber base, reaching 1.07 million at the end of June 2010, representing 32.2% of our total subscriber base.
These are very positive results, and I believe they are a testament to the success of our strategy of focusing on cellular communications, while being committed to delivering quality customer service. As you all know, this is a competitive and constantly evolving industry, and we continue to maintain our position as market leader. So we will continue to work according to our strategy and aim to continue maximizing our performance.
Now turning to some of Cellcom Israel's developments. Again, I think we are showing how our strategy is guiding us to take on very interesting projects with very interesting potential. First, as we reported back in July, Cellcom Israel is entering the financial services market with the intent to launch innovative solutions for conducting everyday financial transactions, using the mobile phone.
We have leading partners in this initiative, Citigroup and Isracard Group to help us realize these plans. We believe that together we will be able to leverage the many untouched opportunities in the cellular business. Moreover, I would like to add the fact that we are the first cellular company to enter the financial services market in Israel.
In addition, we have succeeded to generate additional growth by extending our landline services in the business segment. The Israeli Government recently announced that Cellcom Israel was chosen to operate 20% of their landlines. This is a very exciting development in our landline services, which is one of our growth engines.
Finally, I would like to point out the acquisition of Dynamica has been completed and has already been successfully integrated. This acquisition is already contributing to Cellcom Israel's results, and Yaacov will tell you a bit more about this later.
Now in the area of MoC regulation, we are waiting on the results of the Ministry of Communications hearing regarding the proposed interconnect tariff reduction, payable to cellular operators for which we filed our formal objection. Depending on the outcome, we may continue our case against these proposed changes.
Concurrently, we are continuing to develop measures to mitigate as much as possible the expected adverse impact of these proposed changes. We will of course continue to keep you updated as this situation develops.
In summary, this has been a good quarter and we have seen some very positive developments. We will continue to focus on our core business by remaining committed to providing the best services to our customers and strong financial results for the benefit of our shareholders. I look forward to talking with you again next quarter.
With that I would like to turn the call over to our CFO, Mr. Yaacov Heen, for a detailed review of our financials.
Thank you, Amos, and good day to all of you. As Amos noted, this has been a strong quarter for us with year-over-year growth in all key areas. Our revenues for the second quarter of 2010 increased by 5.2%, totaling NIS 1.7 billion. Within these, service revenues accounted for most of this increase, rising by 5.5%, reaching NIS 1.5 billion.
Revenues from content and value added services increased by 29%, making up 18% of our service revenues. Likewise, we have shown growth in other key areas, including a 12.4% increase in operating income, reaching NIS 499 million for the second quarter of 2010.
Our EBITDA increased by 7.1%, reaching NIS 682 million, and our EBITDA margin totaled 40.3%. In addition, represented 17.7% increase in net income reaching NIS 326 million.
Turning to our KPI. The average MOU increased by 2.4%, totaling 338 minutes compared to 330 minutes in the second quarter of 2009. Particularly encouraging was the growth in ARPU, which increased by 2% reaching NIS 146.6. This rise was attributed to an increase in postpaid subscribers relative to prepaid, as well as to our acquisition of Dynamica.
Indeed, we have already begun to see the benefits of our acquisition of Dynamica, our new subsidiary, bringing in NIS 8 million to our service revenues and NIS 3 million to our EBITDA.
In the second quarter of 2010, we continued to present a strong free cash flow totaling NIS 323 million. If you exclude the acquisition associated with Dynamica, our free cash flow would have reached NIS 431 million. This strong cash flow enables us to distribute a dividend of approximately NIS 310 million, representing approximately 95% of net income for the second quarter to our shareholders.
Please be advised that the dividend declaration is not guaranteed, and is subject to the company's Board of Directors' sole discretion.
With that, I would like to open the call to questions.
(Operator Instructions) The first question is from David Kaplan of Barclays Capital.
David Kaplan - Barclays Capital
The first one, on working capital; in your cash flow, which is the working capital, you report no change in inventory the second quarter versus second quarter last year yet. On the balance sheet the inventory numbers are different. So I'm curious, what else is going in there and how you are calculating few changes in working capital so that it can help model better.
This I think has to do with the new government contract for 20% of their fixed line business, and will that turn the (MAPA) business into a large enough business so that it will be reported as a separate line item in your income statement.
Okay, for the first question, as you said the inventory level has remained almost the same. We decreased the level of inventory by NIS 11 million, and that includes a part of the Dynamica acquisition. So actually we keep this level of inventories. At the end of the last year we saw an increase in the inventory because of the launch of the iPhone.
So there is not any expectation of the market changing the working capital. So the free cash flow mainly is coming from the solid results of the business.
About the second question, to our best knowledge, as we see it today, our estimation that the government will not convert the business to something that will be material in the sense that we'll have to report it separately. But I think that except this, the importance of the fact that we had gained these is more than the business itself.
As it happens with the Army bid that we won a year ago, it helps to put us as a more relevant competitor to the incumbent (digit). So it contributes to our reputation as a relevant vendor to big organizations and to organizations that are very sensitive to the quality of service.
The next question is from Daniel Meron of RBC Capital Markets.
Daniel Meron - RBC Capital Markets
Can you share with us the directional read on what's driving the growth in ARPU this quarter year-over-year? And also, as far as the usage trends when it comes to voice versus data?
I think that unfortunately, I can't put my finger on one activity or one item that generated the results. Unfortunately, I say because it is easier to focus only one item, but it's not the case. The growth came from many, many items that, I can say, of course one of the main is the content which contributed to the growth as you see as a growth of our content. That continuously we are growing higher than the industry. We grew by 28.7%. And even when we are talking about content, we have to remember that content is not one product. Content is contained from actually many products.
One that is worthwhile to mention is the cellular modem that grows rapidly, the use of cellular modem for laptops. And although I hear that we can't object when they were talking to us some two three years ago, the Wi-Fi will actually make the cellular system irrelevant for laptop, we see that it's not the case. Because after all, the consumer is after something that is reliable that is not dependant whether you have coverage of Wi-Fi in the cafés that you sit or not or whether the system is secured or not secured.
So we see, as the laptop sales are growing and then we know that the system is well. Laptop sales are higher than the desktop computer. And then this is not the case as I know not only in Israel, but Israel is very, very clear that this is the situation, and also the increase of sales of cellular modems. So this is one example. And another example is of course something that we are working on is the video consumption. And something that we announced and built doesn't generate revenues, but the financial services.
And I say it because that we select more to depict how we think. Now first of all, we focus very much on everything that is leveraging the mobility. We don't think that we have the synergy or added value in the fixed line business except as I said with the business sector. As I say, in the business sector we have in the infrastructure of the fiber optic that reaches the industrial zones in Israel, which is not the case in the private sector. So this is the reason to remind you that we decided not to enter the landline business in the private sector.
And as I said, we still think that we did the correct thing that we have not entered. Now with the financial services, now again, we don't think that we are experts in banking or financial services. So this is the reason that we made an agreement with Citi, which is one of the leading financial groups in the world, which gives us the financial knowledge and also the institution around the world. And we are not pretending to enter to the banking business where we don't have any advantage. What we are after is to enter only the businesses where mobility is advantaged to the consumer.
And I can say very definitely that since we have synergy, we shall not say in the future, as I can see today that we have significant expenses on this business, because if we have synergy, it should be part of the current system of the company without entering to losses on this business.
Another issue is of course Dynamica, which we acquired, and as it seems today, the integration of the company went well, and we are very pleased with it because we all know that one of the most problematic processes is integrating an acquired company. You know, there are differences in many things, like from the culture of employees to the software, computer system and many items.
In hindsight what we can say is that we managed the process very carefully. And today, the first quarter after the acquisition, we can say that this acquisition was the right thing to do and it contributed to our profit. And also, we believe that the result will be even better in the coming quarters. Without reservation I can say with this respect without saying how much and how significant it will be.
I hope that I answered the question.
Daniel Meron - RBC Capital Markets
Yaacov, if you can help me here with my math, so if do year-over-year, basically it seems like between the growth in data revenue and the growth in Dynamica and the data from Dynamica, that explains most of their growth year-over-year, right?
The growth is coming, as we mentioned, because of the mix of our customer. We continue to improve our customer base towards the post-paid customers. And about NIS 0.8 is the contribution of Dynamica to the ARPU. So this is here to stay, but for the next coming quarter, you have to remember the seasonality, because the next quarter is, because of the Jewish holidays, which is in September this year and in October, so we didn't expect this changes the ARPU.
So generally, we have some trends, such as the new customers, most of them, especially the data user, which is below the average ARPU, as you know. A new modem or a data user, a (NYSE:Q) data user, it's less than the average. But on the other hand, the improvement in the customer base, this trend is towards increasing the ARPU.
So this quarter, we saw this increase; after second quarter an increase in the ARPU. I cannot guarantee anything about the next coming quarter. Especially, you have to remember the seasonality.
Daniel Meron - RBC Capital Markets
You guys seem to have a pretty good traction in the content and data arena. What is the amount or assumption we have thinking about traction with smart phones or other connected devices that you have right now that you see was in the trends or the used patterns and adoption?
We don't give that numbers about the smart phone, but you can imagine that the focus of the company, it's about data. And of course, we continue to increase our smart phone. We want to increase it, but on the other hand, we want to be sure that the customer is happy with this offer. So this is a balance that we have to manage.
Generally speaking, the trend in Israel, about the share of the smart phone is not different than in other markets in the world. So without saying, because we haven't disclosed this number, but the trends are the same. As the consumer prove again and again, if he want mobile internet and not something that is connected to the world, and many other services that you can (view) of course, the accelerated look iPhone, the accelerated trend by the user interface.
But iPhone is not the sole smart phone, because we have some others that are very successful in Israel. So they're all including, as I said, the modem cellular to the laptop shows the general trend of increasing the use of mobile internet everywhere.
(Operator Instructions) Next question is from Darren Shaw of UBS.
Darren Shaw - UBS
I have two questions. Can you just tell us, if there's been any changes in the competitive pressure between you and telephone and Orange in the last couple of months? Specifically in relation to the new policies of marketing of those two companies. And second one is, you mentioned, Amos right at the end about the trend in iPhones have been or smart phones have been similar to another countries. But in other countries most of the players have kind of had problems with the capacity, and bandwidths and things like that, just wondered if you can say if you've had any problems over here? Or whether you perceive as the smart phones keep using up so much data and winning market share if you could see you or the competitors having problems further down the line and how much additional CapEx would you have to spend?
As to the competitive pressure from our competitors, it's always something that we can say is constantly the general trend long along the quarter is increasing competition. But at the same time, I would say nothing very special to the last quarter or there is a change in the trend. This is because we are talking about highly penetrated markets. So every competitor is trying to do something. We sense some change in the beginning of 2009 when Telephone upgraded its network. But except this point of time, I can't say that there is a change in the competitiveness of the competitors. So as I said, market is rather competitive.
Now as the capacity for data on our network, we are really aware what's going in the world regarding this issue. This is a high topic in the industry and especially when we are talking about AT&T case in the U.S. so we are very aware, what's going in the world.
As it comes to Cellcom, yes there is a dramatic increase of the use of data in our network as the sales of smartphone and cellular modem is increasing very rapidly. And now, the best thing that I can say is that we follow very carefully what's going on our network. And we also manage the expectation of our consumers. For example, we made a strategic decision not to compete within land line. There is still the internet, with our cellular makers. What we are saying to the consumer is that we give you something, an advantage that is mobility. And don't expect the cellular network will give you the same speed as fixed network because according to the technology today at least, transferring data package on the fixed line system is cheaper than to do it on the cellular network. So we don't enter to a competition on street level with the land line internet.
And then we also always follow on the capacity and as we see today, we don't have in the coming quarters, we don't see as we can foresee today a bottleneck in this case. And we see that our investment in general speaking will be in the same frame as it is today.
There are no further questions at this time. Mr. Shapira would you like to make a concluding statement?
Yes, thank you very much. Thank you everybody for joining Cellcom Israel second quarter 2010 earnings conference call. I look forward to hosting you again in our next quarter. Good day and [foreign language] happy New Hebrew year, next month.
Thank you. This concludes the Cellcom Israel limited second quarter 2010 results conference call. Thank you for your participation. You may go ahead and disconnect.
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