Portugal Telecom SGPS SA (NYSE:PT)
Q1 2011 Earnings Call
May 26, 2011 11:00 AM ET
Zeinal Bava – Chief Executive Officer
Luís Pacheco de Melo – Chief Financial Officer
Daniel Morris – JP Morgan
Georgios Ierodiaconou – Citi
Jesus Romero – Merrill Lynch
Matthew Robilliard – Exane BNP Paribas
Jonathan Dann – Barclays Capital
Luis Jimnera – HSBC
Greetings. And welcome to the Portugal Telecom 2011 First Quarter Results hosted by CEO, Zeinal Bava; and CFO, Luís Pacheco de Melo. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions)
As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zeinal Bava, CEO for Portugal Telecom. Thank you, Mr. Bava, you maybe begin.
Okay. Thank you very much. Good afternoon, ladies and gentlemen on behalf of my team and I. I would like to thank you for being on this call. We are going to take you through the press release and the presentation, which we made available in our site.
In the numbers that we just put out and following the Vivo transaction on 27 of September 2010, we’ve adjusted our 2010 financial statements in order to recognize Vivo as a discontinued operation and following the acquisition on 28 of March 2011 of a 25.3% stake in Oi and a 14.1% stake in Contax, PT’s statement of financial position at 31 of March 2011 proportionally consolidated the assets and liabilities of these stakes.
In first quarter of 2011, consolidated operating revenues amounted to €871 million, down by 3.9% year-on-year. EBITDA reached €357 million, down by 5.2% year-on-year. Consolidated EBITDA margin stood at 41%. Our net income increased by 29.3% to €130 million and our basic earnings per share stood at about €0.15.
In first quarter 2011, our CapEx decreased 25%, as you know there is some seasonality in CapEx and a decrease year-on-year to €122 million, equivalent to about 14% of revenues. And as you are aware, our CapEx is being primarily directed to the investment in the rollout of new technologies and services, namely the FTTH network and TV service, and to investments in 3G and 3.5G.
In the first quarter 2011, our EBITDA minus CapEx amounted to €235 million, that’s an increasing of 9.9% year-on-year. EBITDA and this is what highlighting, the EBITDA minus CapEx of the Portuguese businesses notwithstanding challenging economic conditions amounted to €229 million, increasing by 7.4% year-on-year.
The operating cash flow and my CFO, Luís Pacheco de Melo will take you through that in a lot more detail amounted to €315 million, which is a substantial increase over the same period last year.
Adjusting for the acquisition of PT’s strategic investment in Oi and in Contax, our free cash flow amounted to €453 million in the first quarter that’s against the negative €6 million in first quarter of 2010.
At the end of March 2011 and following the strategic investment in Oi and Contax, our net debt amounted to €7.429 million, but as you know, we are yet to receive €2 billion from Telefónica and this have been booked as a receivable, so adjusting for this €2 billion, our net debt would have been €5.429 billion (sic) [€5.429 million]. As you also know, this number includes already the unfunded pension liability following the transfer of that liability to the state, which as you know, has been now completed.
Turning now to the KPI, we have another, I would say quarter of good performance across all our businesses, Portugal and international, but in particularly in the Portuguese market in the retail side, residential segment, we continue to do quite well considering that we have reduced significantly promotions compared to the same period last year, which is directly assigned of the rational behavior for whole telecom operators in Portugal.
In 1Q 2011, retail net additions reached 52,000 and this is continue, this is still being driven on the back of the success of our Meo service. The pay-TV service, actually have 46,000 net additions, therefore bringing the total pay-TV customers to 876,000, that’s about a 35.6% increase year-on-year.
We continue to do also very well in broadband, broadband net additions in the quarter were 18,000, but as you know and you will have seen the in the press release, in the residential segment we actually added 22,000 and therefore, this is another quarter where Portugal Telecom has gained market share not just in pay-TV but also in broadband.
It’s also worth mentioning that with regard to pay-TV and fixed broadband, we have an increasing market share for the past 11 consecutive quarters. Traffic generating lines declined only 4,000 in the first quarter and this of course, reflect the positive impact of a triple-play offers.
In the residential segment, this quarter again, we added fixed lines, we actually added another 6,000 lines. So residential segment continues to do fairly well and as I mentioned earlier, we added 22,000 broadband customers as well in this segment. Net disconnections of voice lines were 12,000, but this included 9,000 net disconnections of carrier preselection lines, which as you know, have been reduced to only 87,000 in our market.
Pay-TV customer penetration stands now at 33.7% of traffic generating lines, which I think shows the kind of potential for future growth that exists in pay-TV at Portugal Telecom. It already represents 85.9% of the fixed broadband customer base and it is our belief that the penetration in the demand of pay-TV will continue also to underpin our future performance in terms of broadband as well.
Fibre customers stood at 147,000 at the end of March, this is equivalent to almost 16% penetration we have achieved this in circa 15 months. Having said that, if you look at the penetration of fibre in the household that we have available for commercial sales, penetration is already above 20%, which compares very well with own business assumptions in this regards.
So therefore, what we’re finding is that the Portuguese consumer is welcoming the fibre offers and the Fibre-to-the-home that we have available in this market is a – I would say, structural competitive advantage against all other offers in this market particularly the cable offer.
Retail revenue generating units per access have also gone up. We are now at 1.71 in the first quarter, compared to 1.68 in the fourth quarter of last year, so it now stands at about 1.71.
In terms of mobile, TMN total customers increased by 2.1% to about €7.4 million, underpin by wireless broadband customers with quarterly net additions of 14,000 for postpaid customers and net losses of 19,000 for prepaid customers very much in line with the expected behavior of the consumer in a challenging economic environment.
When comparing our numbers with those of our competitors, you should take into account the fact that postpaid customers in the case of TMN account for 31.1% of our total customer base. The growth of postpaid customers has also been achieved on the back of wireless broadband penetration this is a market which we lead. But it’s also the segment that is being hurt mostly by disconnections and I would say higher control in terms of spend as it basically reflects the behavior of corporate customers in light of the economic situation in Portugal.
Before I go into the details and I take you into a more detail business review, I would just to like to mention that with regard to shareholder remuneration on the back of the cash flow generation you will have seen in our company in the first quarter of this year, we continue to feel very confident about the ability to honor all the commitments that we have made to the market.
We will be paying €0.65 times two -- €0.65 ordinary dividend, €0.65 the second installment of the exceptional dividend on the 3rd of June of this year. With regard to the dividend for fiscal year 2011, we have indicated to the market that we will be paying €0.65, but that we will be having interim dividend, so you should expect another dividend payment from Portugal Telecom probably at the end of this year as an advancement of the dividend for fiscal year 2011.
We believe that we provide a solid and predictable dividend policy which is offering a yield in 2011 of 15.1% that my CFO, Luís Pacheco de Melo will take you through a lot of the financial analysis in more detail in a few minutes.
With regard to our business strategy, you would have seen that in the announcement we made, we have been able to underpin our performance not just on the back of what we’re doing in the residential market in Portugal, but also in terms of cost cutting.
The cost cutting has been achieved because a few years ago we decided to reorganize our business along segments and we decided to manage fixed and mobile as an integrated business in the Portuguese market.
We today are organized along five business segments, five to the customer segment side, residential, personal, SME/SOHO and corporate. Our international investments are also monitored and followed very closely now, where and in all of our businesses internationally we have an active operational involvement.
In order to take advantage of the economies of scale, we’ve also specialized our company, when it comes to the back office and in that regard of course, we also include not just the effort that we are doing around the innovation, but also in all the work that we do around customer care, back office processes, et cetera.
One of the clear advantage of the Portugal Telecom in the Portuguese market is the technology that it is able to offer to its customers, our investment in Fibre-to-the-home is clearly a key distinctive factor and what we’re beginning to see is that customers are beginning to value the fact that we provide symmetric bandwidth for their daily need with individually or business in terms of the internet access.
We are as you know in the sector facing a data tsunami and in that regard I would say all companies that are prepared in most to tackle the requirements in terms of bandwidth and also processing capacity and it is because of this that we are also investing in a very modern data center that we will be one of the biggest data centers in Europe, somewhere in the center of Portugal and that we will hope will allow us to underpin our cloud computing offers, but also allow us to sell capacities, storage and processing to international customers as well.
The [tribal] technology is not just in fixed line, it’s also in mobile. We are preparing ourselves to launch fourth generation mobile or long-term evolution. We have been the first operator in Portugal to try 4G and we already doing live cast in two locations in Portugal.
Also worth mentioning, when it comes to synergies within fixed and mobile that 85% of our mobile stations are now connected with fibre. So in advance so far as being launching long-term evolution we have prepared our transport network, our transmission network in order to cater for the increase in data capacity and also in terms of the requirements of quality service that we have and that we would like to be to – we would like to be the best in this market.
The efforts that Portugal Telecom is doing in technology being recognized by a number of international bodies and I would like to mention here in particular the FTTH council which recently awarded us the prize for having the best FTTH network in Portugal.
So we are cutting edge in terms of technology, technology though we have a structural competitive advantage in this market. It is also worth mentioning that this technology investment is also allowing us to transform our business model in the residential segment but also in the corporate segment.
Last but not the least, I think its worth mentioning that most of the CapEx involved with some this new technologies we have incurred in 2008, 2009 and 2010. So for other companies in Europe, telecom companies, this is still a CapEx to be done sometime in the future, for us that CapEx has already or it is most of it has already been incurred.
And I have mentioned a number of times before that I would like to market to consider that the quality of CapEx of Portugal Telecom is far superior simply because we have invested in new technologies but also because increasingly our CapEx is becoming variable and demand driven, and this is one of the main reasons why you have seen in this first quarter operational cash flow go up, we have not reduced CapEx in the structural investments that we are making in this market.
Our CapEx and our ability to adjust the CapEx is enhanced by the fact that it is demand driven. So if consumer demand is not what is meant to be, you will certainly see the benefits of that in terms of CapEx reduction and therefore cash flow improvement.
We are very happy with the rate of growth of Meo. Our pay-TV service is we believe by far the best pay-TV offer in this market in terms of value and I think especially customers in urban areas where we have – where they have fibre available they’re beginning to see the advantage of actually moving to our FTTH service.
Not only do we offer HD, 3D content, unlimited number of TVs, we also provide you with the only multi-screen experience in this market. It is worth highlighting that Portugal Telecom and this is one of the reasons why our ARPU for residential customers is growing, is that we are beginning to drive revenues in new businesses, businesses like VoD, like interactive, online advertising which is being – which is now possible because we have a very modern and an interactive platform.
With regard to the market demand for these new services, we have included the slide in our presentation, which basically, I think, proves the invisible doubt that Portuguese consumers like innovation.
Perhaps, one good example is a recent interactive content that we have made available, which you probably know, it’s an international format called Biggest Loser and the interactive site that we have made available had 700,000 visits in only two weeks.
The appreciation of the Portuguese consumer of the advantages of having a modern platform, fibre all to the home which gives them symmetrical bandwidth up or down is now beginning to be valued by those customers and we are seeing significant momentum in terms of take up of fibre in our market.
Fibre as you know also allows us to differentiate in terms of quality of service, we – I think have made available this you already in the past. But for example repairs of fibre customer versus ADSL customers tend to be down 85%. When you also look at the churn rate and this was one of the underlying assumptions of our business model that churn rate of fibre customers tends to be much lower somewhere between 5 or 10 percentage points lower than your standard copper customer.
Turning now to an analysis of each segment, residential segment, we continue to see very good growth across the Board, landlines was up, broadband was up, pay-TV was up, retail residential ARPU was also up 3.4%. Of course, this translated into residential revenue growth of 7.8%, which as you know, is higher than the 5% that we reported in the fourth quarter of last year. I think this growth in our residential segment compares very favorably against everything else that other operators in our market are announcing.
Turning to our personal segment, mobile is clearly as you know very cyclical, it’s a – especially in the market where you have a lot of prepaid customers, people tend to adjust their spend fairly quickly. Furthermore, in the Portuguese market last year you saw significantly rational behavior with massive marketing around tribal plans. You also saw significant reduction in mobile termination rates, which was you know in our market in August will be €3.5, which is about 20% lower than the European average.
So when you look at how we responded to this in addition to adjusting prices in January, we have recently launched unlimited tariff plans and we’ve also launched what we call e nunca mais acaba, which an unlimited if you want for prepaid customers offering very, very simple value proposal to them.
You can basically buy unlimited voice SMS package with the additional internet if you so wish for two time periods, all day or evening. The good thing is that in a lot of our customers are buying into this package, they’re buying to this package because they like the simplicity of the tariff plan, they like the ability of control of the cost and also of course, like the unlimited aspect of it albeit that we do have a fair usage policy, but which is very generous and therefore, for most users I think it is the fact of unlimited in real terms.
The market, albeit frankly more rational remains very competitive, especially in the corporate segment. TMN having the largest postpaid customer base in mobile in Portugal is being affected more than its direct competitors.
Of course, when you look at the comparison of our topline, we also compare less wealth simply because use of significant take up of tribal plans in the second half of last year, compared to the first half. And therefore, the comparison of the first quarter of this year to the first quarter of last year to some extend worked against us and we believe that going forward at least some of this comparisons will improve for us.
Having said that, we are not just counting on this best of comparisons we have already launched some of these new tariff plans, which mean in our view far more attractive in terms of value for our customers and what we are seeing is good take up and we also seeing ARPU enhancement.
So it is our belief that whilst the market remains very challenging in the prepaid segment we can stand to do slightly better than and in fact, if you look at the customer revenue performance in the first quarter of this year, it is a slight improvement or if you like it stabilizes the trends of the fourth quarter of last year.
Having said that, in post paid we will continue to see significant pressure in this market, and of course, it remains to be seen also ultimately what will be the impact of the decisions of the next government of Portugal in terms of consumer and corporate demand.
We continue to believe that we have to be the most competitive operator in this market. So with regard to our stance in the market, we will always be the most competitive player in this market, and if we have to be competitive, and if that means that we have to cut costs, we will cut costs as required.
We continue to have in our view the best smartphone offer in this market and we have significantly improved our positioning in terms of the Youth segment. That’s what we have done here, but clearly the signs that we are seeing right now are extremely encouraging.
With regard to the smartphones, we have no doubt in our minds that we are the company that’s driving the biggest market share in terms of distribution and this, if you want, will pave the way for future utilization or more rapid utilization of data as and when the economy improves.
In terms of SMEs, this is where we have done most of the restructuring in terms of how we address the market in terms of distribution channels, in terms of what kind of offers we have for the customers. I think the numbers speak for themselves in terms of fixed line asset. We have gone from minus 18,000 first quarter of 2009 to minus 3,000.
It is worth mentioning here that of course the economic conditions will weigh on the segment but the fact that we have bundled fixed mobile offers, the fact that we have the best distribution network in this country for telecom services, we believe that, and the fact that we have now become far more aggressive in terms of our positioning in the market, this is clearly one of the segments where we believe is work to be done, and some of the investments we made last year will begin to pay in terms of the future.
In this area, I would like to just mention the fact that we have aggressively launched a cloud computing offer in this market. So we have complemented our integrated office box offering. Office box as you know, is a conversion of voice and data offering with access to subsidized equipment, PCs, PBXs and its priced on a per workstation.
We have now complemented that with a cloud computing offer which will enable streamlining of SME cost and will make their CapEx from being fixed to variable specially in this environment where companies are looking to increase their financial flexibility in an environment where companies are like to reduce cost, or like to transform fixed cost into variable costs, we think that the cloud computing offer we think is unbeatable.
Furthermore, it is also worth mentioning that in cloud computing not only we have been awarded ISO:20000 certification but we also are working with companies like Cisco and Microsoft, which in my view, allow us to have a very, very strong offer in this market in this regard.
In the corporate segment, as you have actually seen the numbers data and corporate was down. And it’s down because public administration has frozen a number of their projects. Some of the project that were undertaken last year have come to an end, especially the enabling of the schools in Internet, that was a significant project that contributed to that revenue line. That came to an end, so therefore this year in terms of comparison we will be from a comparison standpoint impacted negatively by that.
Furthermore a number of corporate customers are pushing back some of the investments in terms of IP and so on and that is having an impact in terms of equipment sales as well. So when you think -- when you look at data and corporate and other revenues you will have seen that those have been impacted not just because of these public administration projects, but also by much lower equipment sales.
We believe that, the slide that we have put in the place in the future will make us a lot more immune to economic conditions. This is because we are transforming our legacy telecom software into an ICC offer.
We have seen increasing weight of IPIS on our total revenues. We are also working aggressively in making available a number of machine-to-machine offers as well and with regard to smartphones the penetration in the corporate customers that are customers of Portugal Telecom has gone up 10%.
We think that this will pave the way for a much more aggressive usage of data services in the future, and last but not the least, I think the fact that we have now FTTH as an enabler of much better quality broadband service will certainly be weighed on in the future when people analyze or corporate analyze which supplier they want to be working with.
We are leveraging our technological know-how to transform legacy business into ICT, but we are also doing that by investing, and I mentioned to you earlier that the data center investment that we are making, the cloud computing offers are already available in this market. We are seeing some very good demand already.
Having said that this is an area of business that will require some education on the part of the PT to the market so that people understand the full benefits of actually doing cloud computing, and we are ourselves, Portugal Telecom, expect to be one of the early adopters of cloud computing and use ourselves as a good example as to how we can use these new technologies to reduce costs.
With regard to voice, we will only start consolidating from first of April. Their first quarter’s numbers have already been published. So we wouldn’t like to focus too much on it, other than to say that we are working extremely well with our partners in Brazil and with the management team of Oi so as to ensure that we can bring to back Portugal Telecom’s experience and our partner’s experience in Brazil to turn around the business.
And in that regard, we continue to see Brazil as the market that offers significant growth opportunities in terms of the future, low unemployment, income growth and redistribution, and low penetration both of broadband and Pay-TV.
With regard to mobile, the market continues to be very competitive, but here we also believe that we can bring to them the experience we have especially coming from Vivo in order to ensure that we can enhance the competitive position of Oi in this market as well in the future.
Clearly, there is a lot of work to be done, but the good news is that the partnership is a very solid one and it is a very good partnership and good framework of work that we have on the committee on the telecom’s committee on one hand, and which hold us on the other that allows us to announce recently, as you know, the simplification of our corporate structure, Oi's corporate structure and in that regard we think that this simplification of the structure is a natural step that for the transformation of Oi.
We believe it will bring clear benefits for the company and all of it shareholders having just one representative in Brazil, eliminating five classes of shares increasing the company’s relative importance in all the stock market indices, simplifying the corporate governance, all of this will bring advantages not just financials, but also from a management standpoint as well.
We believe that once you get this restructuring out of the way we should be able to come back to you with a dividend policy statement as well which therefore going forward will make Oi a corporate citizen very much like all other companies in the world, and we believe that that will command a higher coverage from analyst, and no doubt will represent also higher interests from shareholders or investors overall.
The exchange ratios will be defined and negotiated by independent special committees, ensuing to the CBM guidelines 35. There will be one committee per company, and as we have indicated to the market whilst we are happy to work with the committee, we also believe that market prices are good reference point since the conclusion of the capital increases that occurred which allow Portugal Telecom to actually become a strategic investor in Oi represents an objectively verify parameter for the determination of these exchange ratios.
The IR shareholders also, as you know in this process will receive circa 1.5 billion redeemable shares prior to the merger.
One last word. Just about our African and other assets. We saw growth across the board even in those markets where we have seen in the past a substantial or heavy handed regulation like Namibia in Cape Verde.
Having said that, naturally when you look at the numbers of Portugal Telecom you should take into account the fact that from a consolidated standpoint or from 1st of April, Portugal Telecom will have about 88 million customers worldwide, and the waiting of our international businesses will be roughly 58.7 % in terms of revenues and 47.4% in terms of EBITDA.
So we have strong capital generation. We have a very clear strategy. We have a track record of delivery on results. We have discipline on costs, and we have a diversified geographic exposure.
And we now hand you over to my CFO for a much more detailed analysis of the financials. Thank you.
Luís Pacheco de Melo
Thank you, Zeinal. I will conclude by a presentation on the financials of the first quarter. As Zeinal mentioned, our first quarter results already proportionately consolidate our balance sheet of ’08, but there is no consolidation on the P&L. So when you look at the leverage ratio, you should read them with care.
On the revenue side, our revenues declined by 3.9% to 871 million reflecting the challenging conditions in Portugal, and of course notwithstanding significant revenue growth on our international operations.
Wireline revenues declined by 6.6%, and these were relatively due to 10 million lower wholesale revenues. The secular trends in lower revenues stemming from directory business and which accounted for a decrease of 4 million and the lower telecom equipment sales of around 4 million. Notwithstanding challenging conditions, our Wireline retail revenues grew by almost 1% and that was on the back of the residential segment which saw revenues growing 7.8% in the first quarter.
Mobile revenues decreased by 12.4% or 43 million basically reflecting lower customer revenues, which of course, were impacted also by the DAT 3 percentage point increase since the first quarter of last year, also having impact from MTR caps which had a significant impact on our revenue profile.
On the EBITDA front, consolidated EBITDA in the quarter decreased by 5.2%, these were a result of TMN’s EBITDA decline of almost €20 million, which reflected lower revenues, as I mentioned before, and notwithstanding cost cutting of approximately 23 million in the quarter.
As a result, TMN delivered solid EBITDA margins of 47.5% which is basically same margins as last year and 1.6 % point increase in vis-à-vis two years ago. It is worthwhile that two year improvement on the wireline EBITDA which was flat year-on-year and this is the best performance in late quarters and that reflects the strong revenue performance on the residential business. Of course, the scale benefits of the Pay-TV and FTTH, the benefits of the fixed mobile integration and also the relentless focus on cost cutting.
Such programming cost per sub as we have seen in our presentation decreased by more than 14%, commercial costs were down almost 20% and support service costs were also above 18% decline. Additionally, we have put in place several -- tax reductions initiative some of which we have highlighted in our page 9 of our presentation and those should bear some additional results as well.
The results of our Wireless OpEx declined by 10.5% in the quarter and the mobile OpEx declined by 12.5. On the International assets the contribution of our international assets to consolidated revenues were €143 million, at almost 25%, and EBITDA stood at 42 million at almost 3%. On a proportional basis, assuming pro forma consolidation our international assets and adjusting for the Kwanza devaluation revenues and EBITDA grew by 27.5% and 5.2%.
On a Unitel, it is important to highlight that operationally the asset keeps performing well, revenues and EBITDA grew by 13% and slightly more than 2% notwithstanding the effects of the devaluation of the Kwanza which are still being felt. On MTC Namibia, revenue was by 13.9% and EBITDA 10.6%. Of course here, depreciation of the Namibian dollar over the year also helped in this performance.
On East Timor we reached 500,000 customers and launched several marketing initiatives, and the assets keep performing pretty well with revenues up by 16.6% and EBITDA almost 20%. In Cape Verde, Zeinal mentioned with some regulatory impact revenues in EBITDA grew basically 2.8%.
Turning back to the financials on the D&A cost increased by 14% to a 196 million, an increase of 24 million reflecting basically the 18 million increase on the depreciation on our fixed line business, which basically fell due to the Pay-TV service.
On PRBs, PRB decreased to 12 million and that basically reflects the transfer of the unfounded pension obligation to the Portuguese State, and as you know that transaction was fully completed in December 2010.
Net income in the first quarter was up by 29.3% to 130 million, and this performance reflects both in addition to what I have already mentioned, a decrease on the net interest expense of $76 million and higher gains related to affiliated companies mainly due to the total of BRL which had a positive impact of 31 million.
These effects were partially offset by higher D&A primarily on the wireline business as I mentioned, and also on certain financial taxes that we recorded in the first quarter related to investments in Oi. It is basically the [IOS] tax that we have to pay on the money transfer in Brazil.
On the CapEx front, total CapEx decreased by 25%, equivalent to 14% of revenue. The decline in total CapEx reflects mainly lower CapEx on the Wireline side of 30 million on the back of lower cost now related CapEx.
Lower CapEx at TMN of 20% reflects a fixed focus on cash flow generation and consolidation of synergies of fixed mobile integration.
Cash flow as a result of the CapEx decline EBITDA minus CapEx increased by 21 million to 235 million. Operating cash flow increased 13 times to 350 million basically due to the EBITDA minus CapEx increase, and also to the reduction on the working capital investment, which as you may recall on the first quarter -- during the first quarter we anticipated some payments to our suppliers due to the high liquidity that we had at at that point which had the benefits now on the first quarter.
On the free cash flow, it stood at 435 million reflecting the operating cash flow performance, but also the UOL stake disposal and the dividends from a affiliates that accounted for 180 million.
On the financing side, net debt excluding the Oi transaction amounted to 1.6 billion -- more or less 450 million decrease in the first quarter of this year, and this is basically due to the free cash flow generation as I mentioned above.
This 1.6 billion includes 600 million of future payments to the state due to the pension fund transfer, and as you may recall, this pension fund transfer also are tax deductibles and the benefits of that are not reflected on our net debts.
The net debt following the Oi transaction is now 7.4 billion and this is basically due to the 3.7 billion that we invested in Oi plus the proportionate consolidation of almost 2.1 billion of the Oi net debt.
If we adjust our net debt to the 2 billion receivable from Telefónica then the net debt is 5.4 billion, which then translates to a leverage ratio of net debt to EBITDA of 2.1 times. The average cost of our debt decreased from 4.8 to 3.6. This 3.6 excludes the 51 million interest revenue that we received from cash deposits in Brazil, that’s also had the benefit of the high liquidity that we have on the first quarter which we were able to invest at higher rates than our average cost of our debt.
So you shouldn’t expect the same type of -- cost of debt on the second quarter due to that, most likely our cost of debt excluding the feeling that second quarter should be around 4.3%.
Finally, we’re on the €1.8 billion finance that we have already executed in 2011, €600 million on the Eurobond and €1.2 billion on the credit line facility, which paid to international banks, coming from continental Europe, U.K. U.S., Brazil and Japan. Following this transactions our funding liquidity stands at €6.6 million, which fully covers of our maturities until the end of 2013.
On the pension fund, the following difference of the pension fund we still keep the healthcare benefit and some of small pension funds and our PBO amounted to €471 million for which we have €425 million in assets.
In addition to that, we also have the liability of future salaries to pre-retired employees of almost €900 billion and as a result of that the total unfunded pension obligation after tax stands now at €706 million.
In addition to our Portuguese pension fund obligations, now we consolidate almost €52 million PBO coming from Meo. As you know most of the Meo plan are already for the new participants.
Let me now hand you over to Zeinal Bava for his final remarks.
Okay. Thank you very much Luís. So just to wrap up and perhaps, I’ll just highlight a few points. The first is, we are comfortable with the consensus. Although, we understand that the economic environment is very challenging and that we have the commitment to remain as competitive as we can in this market, we are now prepared to loss share in mobile. We actually want to continue to build market share in pay-TV and broadband. So with that caveat, I’ll say that we’re very comfortable with the consensus.
In the Portuguese market we believe that, we’ve seen what the impact of the austerity measures are likely to be, we have elections on the 5th of June. So post that, I think, we will have to maintain close dialogue with you so that you can be up to speed as to what’s going on in our market here.
Having said that, 58% of our revenues are generated outside Portugal and almost 40 odd percent of our EBITDA is generate also outside Portugal, so that means that our geographic exposure hedges us against any potential headwinds that we may have in the Portuguese market that may end up being unexpected.
And you have seen in this quarter, our determination, our results to cut costs and all cost lines have come down in the fixed line operating costs were down 10.5%, in mobile cost were down 12.5%, you saw margin improvements in fixed line about 200 basis points, you saw margins in mobile at 47%.
We also saw our cash flow reach €453 -- free cash flow reached €453.5 million and our EBITDA minus CapEx reached €235 million in the domestic market. Our EBITDA minus CapEx in our fixed line business was up more than 38%, this I think boost the unreasonable doubt that we had committed to generate cash flow in order to continue to honor our commitments.
We continue to have significant financial discipline and cost discipline and scrutiny as to where is it that we allocate capital depending also on the returns that we are able to generate in order to create shareholder value.
Our net debt to EBITDA is 2.1 times, as Luis mentioned, we have €6.6 million of liquidity, this means that we have no refinancing until end of 2013, early 2014. So with regard to what’s going on in the Portuguese market, I would say again, the conservative management of our balance sheet gives us the flexibility to continue to take strategy decisions and to continue to invest in those business that generate value always thinking medium to long-term.
To conclude, I’ll say that all this allows us, I think to say also that we have solid cash flow generation and we have given to the market a very predictable dividend policy with the intention to pay dividend, all the way up to 2014, progressive dividend. And we’ve also indicated our willingness to pay this on an interim basis.
So I think that all in all this makes our investment case pretty unique in the telecom sector, worth also mentioning is the optionality that we have from our investment in Brazil, which is really a turnaround story, but it’s a story where we believe that by working together with our partners there, we will be able to create shareholder value in the future.
Thank you very much for being on this call and of course, my team and I are now available to answer any questions you may have. Thank you.
(Operator Instructions) Our first question comes from Daniel Morris with JP Morgan. Please state your question.
Daniel Morris – JP Morgan
Yeah. Good afternoon. A couple of questions please. Firstly, the CapEx run rate in the first quarter seem to suggest, you might be holding back a bit on the fibre investment in terms of the services under household, as well as benefiting from the lower customer investment. Could you update us on you fibre plans and what the key investments was given the economic backdrop and also expectation to domestic CapEx this year?
Secondly, could you comment on the spectrum auction from those from those Managem when do you expect the auction to occur, which you bid on a little block under the current pricing and how do you feel about the implied megahertz for pop pricing, which I think is around €0.50, if I remember? Thank you.
Okay. Thank you, Daniel. With regard to CapEx, we as you know have revised our guidance from early indication of €725 to roughly having a CapEx inline with what we’ve spend last year, which was roughly $657 million for the Portuguese businesses.
Of course, if you look at the run rate in the first quarter, it will seem to suggest that we can reduce CapEx well below €657. But I think I would not advise you to do that right now. I think we continue to stick to the €657 million guidance we’ve provided, perhaps more robust now than in the past, we’ve set in the past €650 to €700, I think now it’s probably going to be €650, €650 sort of €657.
With regard to our fibre investments, we continue to believe that it is an investment that creates value. We have intention to build an extra 600,000. We would like to construct most of those 600,000 this year, by the end of the year.
Having said that, as we have indicated in the past, the ability and the agility of Portugal Telecom allows us to alter any plans that we have in pretty short notice. So looking at things as they are today, we continue to believe that we should progress those investments also because what we are seeing is that in those areas where we have copper and fibre people are buying more fibre.
We also believe that the value proposition of fibre is allowing us win back customers that move from Portugal Telecom to a cable service in the past few years. So in those urban areas where you have more GDP per capita we are gaining market share and very important and valuable market share.
So, and also when I look at the maintenance and repair and customer care costs, I would say that the business case that we have for fibre actually stick very well together, so therefore we have no intention of scaling back that project.
But we will certainly manage it in accordance with any headwinds that we may or may not get and the competition take is that the way we organize today as a company, we can actually adjust the CapEx very fast.
Also worth mentioning is that, 30% of our sort of total Portuguese CapEx is roughly, is customer CapEx. So the competition also have is that if demand does slow we will incur less customer CapEx, worth also mentioning here is regional shift Meo that is responsible for our purchasing unit. We also are seeing equipment price has come down substantially and we have seen that happen in the last two to three quarter. So of course, we are taking full advantage of that.
So we will continue to invest in fibre. We think it will underpin market share gains and helps us reduce costs. Churn and all this is actually very much inline with what we have in our business plan and therefore, we have no intention of changing that.
With regard to the spectrum, we think that initial timetable that was indicated is unlikely to materialize, so there will be delay. With regard to our position for obvious commercial reasons, I will not go into detail other then to say we are leaders in mobile in this market and we are already doing pilots of LTE.
We believe that the fact that we have invested significant amount in fibre and in our transition network gives us substantial competitive advantage, which we can bring to back as and when we have long-term evaluation and therefore from that standpoint if we are looking at the depth in our date of tsunami in terms of the future, where we would like to have the best offer in this market in both [bandwidth] and fixed in terms of mobile.
So we will be there, we are ready to launch long-term evolution, we are ready to bid. But I think at this stage, I prefer not to say a lot more because it is a competitive process. Thank you.
Daniel Morris – JP Morgan
Thanks very much.
Our next question comes from Georgios Ierodiaconou with Citi. Please state your question.
Georgios Ierodiaconou – Citi
Thank you. Good afternoon. I have two questions. The first one on OpEx in the guideline, we’re seeing around 12% reduction in the employee expenses this quarter, for what I understood during the presentation, you expect this to carry on the similar pace for the rest of the year.
Is that consistent with worth you would expect to see going forward or is it – is project that will exhaust this year? And perhaps, if you could give us an indication whether in the past you commented that by the end of 2011, you hope to be delivering positive EBITDA in fixed is that still something you believe is achievable?
And my second question is on mobile, during the fourth quarter conference call, you kind of prepare does for an increase in commercial costs or maybe decline in margins. Do I sense that this has changed over the last three month and is there chance that carries out the competitive environment has improved or is it just something that you’re trying to be a bit more conscious perhaps earlier? Thank you.
Okay. Thank you. With regard to the adjustment that we wanted to do in wages and salaries, I think we have done those. And as you know, we are believers in business process reengineering and bottom up cost cutting and therefore, what we like to do is to, number one, ensure that we simplify processes so that – simplify processes so that we can reduce costs.
I think what we’re doing in customer care is one very good example of it. The fact that we have launched our healthcare platform, we believe that is one interesting avenue for us to reduce substantially customer care cost in terms of future. So our priorities to do business process reengineering.
Number two, is to reduce cash cost at Portugal Telecom, so if there are function activities that have been outsourced that we can insource and use that to crystallize efficiency gains that we are seeing. We will prefer to do that instead.
So I think with regard to adjustments that we wanted to do, in terms in the wages and salaries line, I think we have done what we have to do. We will of course continue to work costs down in all other areas and I think as you’ll have seen in our press release in all areas you have seen cost reductions and we have already launched a number of initiatives in the last, I would say we started this process, seven, eight months ago, which is, in our company a very continue -- is a continuous process, we have always been very cost conscious, but we have accelerated some of the decisions in the last six, seven months, we have launched few of this three months ago.
And again, just for you to know, next couple of days I’ll be seeing my leadership team here in Portugal and we will be taking a number of other decisions to continue this cost cutting effort, notwithstanding the fact that we believe that things are progressing according to plan.
With regard to EBITDA performance, we have reached flat EBITDA in the first quarter, which is comes as a surprise, this is the best performance in our fixed line business in the last 18 quarters, so we’re talking about it’s the best performance in the 4.5 years. We continue to believe that it is a turnaround in terms of EBITDA, which is sustainable.
Having said that, we need to see what the final impact of the austerity measures are and particularly what that impact is likely to be in the cooperate segment, which we believe is much more exposed before we actually commit to being more bullish in that regard.
I mean the first quarter is very good news we believe, we are working now on the second quarter, we think that certainly we are going to do better than what we did last year. But whether how sustainable this is will depend also what happens in the next kind of two to three years, also in terms of the news flow around the economy, but the results to continue to surprise on the upside is certainly there.
With regard to mobile, the sector, I would say, its more rational then it use to be, having said that, we still continue to see irrational behavior especially in the corporate segment. Our competitors overly aggressive, I mean question earlier was regarding long-term evolution.
I think people have to understand that this is the sector, which is capital intensive with long pay back, and any cooperators are not rational in the way that they try to services. It is unlikely to generate cash flow for them to continue to invest long-term in this business. This is how we Portugal Telecom approach this.
Having said that, we will be as competitive as the most competitive offer in this market, we are not going to lose market share. And if I have to cut cost, you know to compensate for any investments that we make in commercial cost, we will do that and we are prepare to do.
So I would say that mobile slightly more rational in the youth segment but in the postpaid segment, pretty rational, which means that, with regards to the margins, I would just reiterate what I said in the past. We are very comfortable with plus 40% margin. Last year margins isolated somewhere between 43% and 47% with the guidance that we gave was plus 40% and I would like to maintain that guidance at plus 40% in this call as well. Thank you.
Thank you. Our next question comes from Jesus Romero with Merrill Lynch. Please state your question.
Jesus Romero – Merrill Lynch
Yeah. I have two questions. The first one on fibre, you have a 147,000 customers, I’m wondering, you can give us the indication of what are the ARPU for this customer pace, I know you don’t disclose that in the press release, but as you could give us some sense of what the numbers could be and what kind of penetration you expect at the end of the year when you get to the 1.6 million plus home spot?
And then the second one on mobile, we’re seeing a very improvement in the customer revenue in the first quarter you still have difficult comparisons in the next couple of quarters. But in the relation is a bit of a, do you see a bit of an improvement in the next couple of quarters, have we seen the worse in service revenue decline with 12% in Q1? Thanks.
Okay. Thank you. With regard to fibre – thank you Jesus. With regard to fibre and we are seeing penetration of like 23% if you take into account that not all homes are available for sales day one. So 23% is extremely encouraging. I mean in the industry, I would say that that’s a very good benchmark, considering that we have made fibre available in this market and it’s being like 14, 15 months.
And we offer three speeds in terms of for fibre customer, 100 megs, 50 megs and 24 megs. Clearly, the most popular speed is 24 megs. Having said that, I would like to say that as people understand the advantages of having more bandwidth, more speed as they become a custom to having 3D content, more HD content, we have no doubts in our mind that we will enable those customers, with much higher speeds in the future.
And also the churn of this customers is extremely encouraging, if I may perhaps some of the churn that we are seeing is explained by, I would say not very good quality sales that we have done, sales to those customers that are incapable of paying for such a premium service, but if you were to adjust for that.
I would say that the churn of the fibre service is significantly better to that of our ADSL copper, perhaps I would say kind of 10 percentage points lower, which in my view is very good, if you thinking along the lines of customer lifetime value.
What is the ARPU enhancement, somewhere between €3 and €5, it depends also on the promotions. Now this is the first year of the fibre rollout and of course, we have promotions out there with these early adaptors of this new technology. And therefore, I would expect the ARPU uplift to increase in the future, not just because this promotions will end, but also because we are likely to see upgrades of speed, as we make available more sophisticated services and content that demand more bandwidth.
With regard to mobile, termination rate will be $3.5 in August. They will be 20% lower than the European average. Recently I made a presentation and I was talking to a number of people regarding the role of the telecom sector in the Portuguese economy.
When you look at the inflation, we were the only deflator of all sectors in this economy, okay, which, if you look at the last five years. So the market is very competitive. Prices are extremely competitive and I think the numbers, I think speak for themselves.
So with $3.5, mobile termination rate, we will be about the same where Germany is, we will be lower than Denmark and we will be 20% below the European Union. I think, it is worth highlighting is that the drops in termination rates in our market have been extremely acute, against the backdrop where mobile operators have been asked to make investments in long-term evolution.
This is something that’s need to be taken into account also by the regulators. We always say that we need to have a predictable regulatory framework in order to continue to invest because investments in our sector are increasingly -- have increasingly longer paybacks.
With regards to customer revenues, after this year improvement, I think part of that improvement has to do with the success of our unlimited plans, bid for prepaid, bid for the internet. We need to see how those develop in the future.
I would say the indications are positive and having said that, I will repeat what I said earlier in the earlier question, we need to see what the austerity measures are ultimately, what the impact is before we can guide you in any given direction. Having said that, I’ll say that we are comfortable with the consensus so far and we see no reason why we should change that guidance.
Jesus Romero – Merrill Lynch
Our next question comes from Matthew Robilliard with Exane BNP Paribas. Please state your question.
Matthew Robilliard – Exane BNP Paribas
Good afternoon. Two questions for you. First, with regard to Timor, I know its early days, but, maybe if you could talk a little about what you think some of the priorities, you mentioned corporate restructuring but thinking more about the market, you think from a regulatory point of view there are some evolutions that could be needed, interesting in the Brazilian market?
Second, with regards to financial expenses, Luis highlighted very low financial expenses, financial interest that you paying and I wanted to know with regards to what was coming to for the Q2 the €4.3, is that included the financial costs that will be related to Timor, which I would have expected to be quite materially high and bringing the average higher. So, just wanted to clarify if the €4.3, you’re talking about for Q2 and the rest of the year doing through to the financial expenses of -- that will consolidate with Timor?
And finally, just a point of -- just to check, you mentioned you’re comfortable with the consensus, if you could maybe just give us a few numbers to where you think the consensus is? Thank you.
Okay. Thank you. With regard Timor and I think as I have mentioned before, we see that clearly, there are three levers in terms of unleashing value. Clearly, one of them relates to the restructuring for -- if aren’t simplifying the corporate structure, is one very big step in the right direction. I think the fact that we were able to announce this restructuring so fast, I think it confirms how good the relationship is between, for example, Portugal Telecom, iG, La Fonte and the Fundo.
So I think the fact that we have been able to kind of the next – the last six weeks been able to get our heads together and then come out with such an important announcement, just make to sure that the termination, the result of all shareholders of Oi is to enhance value in the future and to reposition the company, so that it can be and it can reclaim the leadership position that it should command in-depth market.
The second lever is clearly regulations. You certainly know that in the telecoms market, regulation has a direct impact on whatever strategy you may want or you may not want to implement. If regulations doesn’t allows you to offer T.V., you can now move from double-play to triple-play, if terminations rates in mobile are extremely high, you are likely to face significant fixed mobile cannibalization, which could threaten the sustainability of the business model of the fixed line.
If you weigh too much on the Universal Service Obligations of income operators, like in Portugal. I mean, we are the guys that actually provide Universal Service Obligations and that can take away a lot of flexibility of the company to invest in new technologies.
If you don’t make those obligations more flexible then you are likely also to miss out on the opportunity of using more efficient technology to deliver the same service. So the second lever clearly is regulation.
The third has to do with our ability to turnaround the operations. And there I would say that, the fact that today, Oi is controlling shareholding group, includes an operator such as Portugal Telecom will certainly help.
I have been spending a lot of time in Brazil, myself with my team and I think there is a lot of potential for Portugal Telecom and Oi to work together to extract synergies, to share best practices, to align strategies and I would say that the response we’ve had both from the management team and our core shareholders is extremely positive.
Likewise, I think Portugal Telecom will also benefit from learning from Oi, there are certain challenges in that market, that come from the fact that it’s a large market, with a continental dimension, with other challenges and I think that the sharing of these experiences will be beneficial for PT on one hand and Oi on the other hand.
So, we remain confident about our ability to work together with our partners in order to ensure that we can bring together the experience of Portugal Telecom and fixed mobile. Leveraging on what is a very strong franchise that Oi has in that market already, so that we can do better in the future.
So that we can create more shareholder value for concerned and the fact that we were able to announce the simplification of our structure in six weeks, it’s a good testimony, that’s one, Portugal, this is a strategic investment for Portugal Telecom. Number two, that the relationship between the partners is a very good one.
So, with regard to the turnaround, the strategy of Oi and so on, I think you have to allow a bit more time so that we can all do our homework, so that we can articulate at some stage in the future, a strategy that you can then hold against us in terms of execution.
But, I think its early days for us to do that. Other than to say, that we see significant scope for cost cutting, we see significant scope for broadband penetration, pay-TV penetration and clearly, fixed mobile convergence.
And I spent last week, four days in Brazil. I’m very impressed with the Oi operational team. They have very good team. That is very knowledgeable about the market and I’m sure that that team working together with our team here in Portugal will certainly – will certainly have a very good shot at trying to improve the performance of that company in the future. Luis?
Luís Pacheco de Melo
Matthew, the number that I mentioned of €4.3 was just for the ex-Brazil, cost of debt of €4.3, but if you can probably see the Oi cost of debt in the first quarter was around 98% of CDI and CDI now spends more or less up to 11.9% in reais. But the €4.3 that I mentioned, it was just for and ex-Brazil debt, so the one that compares with the €3.6 in the first quarter.
With regards to the consensus that we have is for the wireline business EBITDA €730, on TMN €560 and on CapEx is, Zeinal mentioned the guidance that we’re giving now is around €657, €660, so it should be around €660 -- €660, sorry.
Matthew Robilliard – Exane BNP Paribas
Luís Pacheco de Melo
Thank you very much.
Thank you. Our next question comes from Jonathan Dann with Barclays Capital. Please state your question.
Jonathan Dann – Barclays Capital
Two parts. First, could you walk; you mentioned that dividend from and a dividend policy from Oi. Could you provide some clarity about whether that’s a payout ratio of earnings or cash flow?
And secondly, could you provide some more color around the sort of the eventual economic stake you could end up with in Oi post the reorganization and any scenarios around take up or otherwise of the local rights?
Okay. Thank you. I think, with regard to the dividend policy, it’s only we are actually having a discussion about this, once we have restructured the company and Oi then just becomes one listed company with two classes of share boosting numbers in, where there is clarity and the cash flow is visible, so that we then can come back to the market with a statement, which we can then of course honor and then you can hold against us.
I think until we have done that, it is difficult to provide you a guidance or how it is that you should look at it. If I prefer to be at this stage cautious other than to say that one of the positive or benefits of doing the restructuring is that it will allow us to define a dividend policy.
A define a dividend policy so that Oi can be looked at and treated like any other corporate entity that has been trading or is trading in the market. I think that predictability and that visibility of dividends in my view will also enhance the perceived value and the valuation multiples of that company.
With regard to economic stage after the simplification of the structure, we think that it depends on the assumptions that you may have on the [direct] effects, but we think that our stake would be at least 21.5%, possibly more. And I would say perhaps, likely more than 21.5% and you also have – you also know the deal is likely to be accretive for us in terms of revenues and EBITDA and also dividend payments.
But I think that more exact numbers will very much depend on your assumptions on the sale of the minorities shares to the companies, which is the right that they have in that market, but I would say that 21.5% is the minimum and most likely higher than that and accretive for Portugal Telecom.
Thank you. Our next question comes from [Luis Jimnera] with HSBC. Please state your question.
Luis Jimnera – HSBC
Yeah. Good afternoon. The first question is on the Portuguese mobile business. You mentioned about data tsunami and I was wondering how does this reconcile with your unlimited data tariffs, we’ve seen other of your peers in Europe were shifting to tier data plans and also wanted to ask, if you had seen any signal of sort of KPN effect in your performance with out of then those revenues been cannibalized by, for example, instant messaging?
And the second question is on the fixed line side. Obviously, good numbers on the residential revenues and then more benign competitive environment with (inaudible) trying to stabilize or increased pricing. Do you think this is sustainable and also do you see as an icon and the other embundler are being more rational along the pricing side as well? Thanks.
Okay. Thank you. And as you know in the Portuguese market, SMSes, essentially, if you are thinking about the heavy users, the used segment, there have been pretty much free for the past 12 to 18 months. So we -- if you want, have already felt that impact sometime ago and that was part of the irrational behavior of the Portuguese mobile market.
So, from that standpoint, I think, we have gone through that and so when we talk about, for example, tribal plans, SMSes are for free, only SMSes are for free and as you know these tribal plans essentially work on the basis of the network effect as oppose to off net traffic.
We are of course seeing some impact, especially for those that are not so heavy users of SMS, some impact but I would say it’s less material. I would say the benefits of actually being able to get them buying an internet, a mobile internet service in our view, in our case is accretive because of the legacy of the SMSes been free in this market.
Also, worth highlighting is that, as we say, with regard to data, the Portuguese market has been very rational. So mobile internet or broadband for that matter has been rationally priced and I think that happen also with the fact that everyone acknowledge and they understand that 3G may not be the best technology to actually offer a data service and perhaps, they may change to long-term evolution. But then, again, long-term evolution is likely to have much lower costs in terms of operations, so once you go right over the year, will be much, much cheaper to carry that it is for 3G right now.
With regard to Zon, to be honest with you, we, Portugal Telecom were, we have our own strategy. We are in this business to provide our customers best value for money. We like to be the best buy in this market and we like to be very cost -- we like to have huge amount of costs discipline, so that we can maintain full flexibilities to be as competitive as required in the market.
I would say that the market is more rational. Having said that, I think that it could still be more rational than it is today, but we are delivering on our market share objectives and we are also quite happy with the way that which we are growing right now. So we have scaled back promotions and we’ve scaled back the promotions also because in this environment, we want to make sure that customers that are buying our service are those customers that can actually afford it, because there’s no point in you selling or booking revenues on one hand and provisions on the other.
So I think this discipline as to how we would like to position ourselves in the market, is something that we are very proud of. And but I would say that it’s more rational and it used to be last year but it could always change.
So we are always out there, trying to be as competitive as we can and it is – the message is very clear. We are not going to lose customers on price and if I had to cut cost, to compensate for that, we will do that in order to maintain the margins where they are.
Luis Jimnera – HSBC
Okay. Thank you.
Thank you. I will now turn the conference back over to management for closing remarks. Thank you.
Okay. Thank you very much for being on this call and on behalf of my team and I, we are of course available to answer any questions you may have through our IR Director, Nuno Vieira, by e-mail or by call. And we hope to see you.
We are starting our road show next week and we will be also attending some Investor conferences as well. So we certainly hope to see you there and if there are any further questions, we will be very happy to take them on those Investor meetings or Analysts meetings as well. Again, thank you very much and bye-bye.
Thank you. This concludes today's conference. All parties may now disconnect. Have a great day.
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