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Cellcom Israel Ltd. (NYSE:CEL)

Q2 2011 Earnings Call

August 8, 2011 9:00 AM ET

Executives

Ehud Helft – CCG Investor Relations

Amos Shapira – President and CEO

Yaacov Heen – CFO

Analysts

David Kaplan – Barclays Capital

Simon Marks (ph) – Citibank

Louie DiPalma – William Blair

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Cellcom Israel Ltd Second Quarter 2011 Results Conference Call. All participants at present in listen-only mode. Following management’s formal presentation instructions will be given for the question and answer session. (Operator Instructions). As a reminder this conference is being recorded August 8, 2011.

I would now like to hand over the call over to Mr. Ehud Helft of CCG Investor Relations. Mr. Helft would you like to begin.

Ehud Helft

Thank you. 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 on the line are Mr. Amos Shapira, the CEO; and Mr. Yaacov Heen, the CFO.

Mr. Shapira will open by providing a summary of the main highlights of the second quarter 2011 results, followed by Mr. Heen, who will review Cellcom’s financial performance in further detail.

Before I turn over the call 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 of 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, 2010 and 20-F filed with the SEC.

In addition, any projections as to the company’s future performance represent management’s estimates as of today, August 8, 2011. Cellcom Israel assumes no obligation to update these projections in the future as market conditions may change. You should also, by now, have received a copy of the company’s press release. And if you have not yet received so, please call CCG Investor Relations at 1-646-233-2161.

And now, I would like to hand over the call to Mr. Shapira. Amos, please.

Amos Shapira

Thank you, Ehud. Good day everyone, and welcome to our second quarter 2011 earnings conference call. As we expected and reported this quarter demonstrated the strong impact of the regulatory changes which came into effect at the beginning of the year also affecting our results was the implementation of additional customer service and pricing plan measures in order to better address the current market conditions and increase competition.

Our total revenues decreased by 6% and service revenues decreased by 24.5% compared with the second quarter last year, most of it due to the reduction of interconnect fees, but also due to the intensified competition. Revenues from content and value added services increased 5.2%, EBITDA decreased approximately 17% and net income decreased approximately 25% compared with the second quarter last year.

As in the first quarter, regulatory changes and accelerated competition led to a material increase in the company’s gross recruitment of subscribers, as well as to a 137% increase in revenues from handsets and accessories compared with the second quarter last year, most of which resulted from an increased sale of smartphones and advanced 3G handsets.

As the number of customers’ queries to our sales and service centers increased, we continue to increase our sales and customer service force during the second quarter in order to provide our customers the best service. We are confident that these steps will serve us given the increased competition we face.

I am very pleased with the work we have done in improving our customer base and strengthening our relations with our customers. This particularly demonstrated by the ‘Brands Index’ as well as by reports from the "Israeli Consumer Council" and the "Public Trust" organization, which will be detailed shortly.

During the quarter, we added (ph) approximately 20,000 net post-paid subscribers, characterized by higher than average revenues, while our pre-paid subscriber base decreased resulting from the termination of customer accounts which brought no money in. We are very pleased with this trend and expect it to continue.

I am very proud to note, that in 2011 Brands Index’, which ranks the top 100 brands in Israel, Cellcom Israel ranked among all Israeli brands including all communications and cellular brands in Israel.

Overall, Cellcom Israel ranked number four in Israel, coming after three prestigious global brands. The Brands Index of compared by Globes, a leading Israeli financial newspaper and is considered the most prestigious brand index in Israel. A company’s brand reflects its credibility among customers and represents the trust and preference among consumers for that brand over other brands.

Our investment in our customer service was also reflected in the "Public Trust" organization for the first half of 2011 and which was recently published. It states that although Cellcom Israel has the largest subscriber base among the cellular companies in Israel, it receives the lowest number of customer complaints. This report is consistent with previous "Public Trust" organization report as well the "Israeli Consumer Council" report.

These two achievements are undoubtedly the result of our investment in all of the Company’s units particularly the investment in our customer service unit made both over the last few months and a long period of time. I am confident that these efforts will serve as a solid basis of our company for expected increase competition in the near future.

Now turning to Netvision. Following our previous announcements with regard to a potential merger with Netvision, both general meetings of shareholders of Cellcom Israel and Netvision approved the merger. Likewise, additional approvals were received by the Ministry of Communications and the Israeli Antitrust Authority.

We have already begun the preparation for the expected merger in order to leverage the potential synergy and to create better capabilities to cope with the changing market without losing the managerial focus of each company during the merger process. The implementation of this activity will be executed if and when the merger will be completed, while maintaining the company’s focus on its core business.

In closing, this has been a challenging quarter, but, we have also seen some positive news. I believe this is a result of our efforts and ability to stay focused on mobile communications, while entering the landline services to the homes or the acquisition of an existing business. We remain as always 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 review of our financials. Yaacov, please.

Yaacov Heen

Thank you, Amos and good day to all of you. I will now provide the more detailed overview of our financials. As Amos mentioned, we continue to see the impact of the regulatory changes and the increase competition has on our results as well as on the market as a whole.

The reduction of interconnect fees as well as ongoing price erosion adversely effected our service revenues and profitability and we estimate that they will continue to affect our results. And we predicted last quarter the increased sale of handsets caused a decrease in our free cash flow this is because the company makes immediate payments to vendors for handset purchases, as opposed to spreading the proceeds from those sales which are generally made by our customers in 36 installments.

Now, moving on to our financial highlights. Revenues for the second quarter of 2011 totaled NIS1,589 million decreasing by 6% year-over-year. The decline can be attributed to a 24.5% decrease in service revenues due to the regulatory changes. This was partially offset by a 137% increase in revenues from handset, which totaled NIS458 million. Revenues from content and value added services increased by 5%, making up about 25% of our service revenues.

Operating income decreased 20.4% totaling NIS397 million, while EBITDA decreased 17.2%, totaling NIS565 million.

Financing expenses for the second quarter totaled NIS75 million compared with NIS61 million in the same quarter last year. This increase resulted mainly from the increasing interest expenses associated with the company’s debentures due to the higher debt level. This increase was partially offset by an increase in deposit, interest income as a result of higher deposit balance and interest rate.

Net income decreased by 25.2%, totaling NIS244 million.

Turning to our KPIs. MOU for the second quarter 2011 totaled 342 minutes, compared with 338 minutes in the 2010, an increase of 1.2%.

ARPU totaled NIS108.2, decreasing by 26.2% year on year. As noted before, this decline is due to the decrease in interconnect fees and increased competition.

Free cash flow for the second quarter of 2011 totaled NIS174 million, a decline of 46.1% compared with same quarter last year. As mentioned before, this decrease is mainly due to time difference between payment to vendors and the proceeds coming from our customers.

We’ll distribute a dividend of approximately NIS232 million, representing approximately 95% of net income for the second quarter to our shareholders. Please be advised that the dividend distribution not guaranteed and it is subjected to the company’s Board of Directors sole discretion.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from David Kaplan of Barclays Capital. Please, go ahead.

David Kaplan – Barclays Capital

Hi, good afternoon everyone. I have – my first question is on net debt. I know that you guys have the perspective about raise, which mean 300 to NIS500 million in Israel. That seems to me like it would take your net debt to EBITDA ratio to around 1.8 times. Is that something the company feels comfortable with? Is there a target, net debt to EBITDA leverage or leverage ratio that Cellcom is looking for?

Yaacov Heen

Yes, as you said, we expect that net debt to EBITDA will be higher after we accomplish the acquisition of Netvision. When you look around, the ratio is about 2 to 2.5. Net debt to EBITDA, this is average in the industry and we believe that we can be in this level. And as you said, it’s about to in the near future.

David Kaplan – Barclays Capital

Do you foresee any response from the credit – from the rating agencies of rating your debt if you are over two times?

Yaacov Heen

No, the limit is about more than 2.5.

David Kaplan – Barclays Capital

Okay, all right. And then, just a quick question on Cellcom in the past has been very good at operating efficiencies and cutting cost. I obviously understand that in the current competitive environment, marketing is not an expense that is able to be cut. But, can you talk a little about when you think about the second half of this year or even 2012 unless that’s too far out and where you see Cellcom’s ability to become more efficient.

Amos Shapira

I can’t give you clear and definite indication about the future. The only thing that I can tell you is that Cellcom is a management team, as not ever stopped the efforts to increase efficiency. It’s an ongoing business. It’s an ongoing activity actually. We have a weekly meeting dealing with increasing efficiency.

Now, I would add also another thing is that we are exploiting the process of the merger between Netvision and then Cellcom also as a leverage to examine every process that we are doing in both Cellcom and Netvision and then we shall examine the synergies and how are going to integrate and the two companies. So, I can’t give you a clear picture whether about how much potential we see. But, this is under a continuous effort all the time.

David Kaplan – Barclays Capital

Okay, thanks. And then, last question on CapEx. The first half of this year, it seems like CapEx was lower than we were looking for. Are there any projects online or can we expect the same levels of around 5% of revenues on capital expenditures.

Yaacov Heen

First, they decrease when you compare to the corresponding quarter or first half of 2010. Of course, it’s going to be lower because of the change in our capitalization method both in subsidy and commission. So, we are going to see an increase in the cost. That’s why, this margin is also affected. And positive impact is on the CapEx, which will be lower. So, it’s more accounting than economy because it’s the same numbers, first. And second, as we said in the last quarter, we have a delay in our investment plan. We just signed a contract with Nokia Siemens. Now it’s public. And that’s why we believe that the second half of the year, we are going to accomplish our CapEx plan. So, we can stay with our guidance about to be not more than 10% of our revenues.

David Kaplan – Barclays Capital

Great. Thanks very much.

Operator

The next question is from Simon Marks (ph) of Citibank. Please go ahead.

Simon Marks – Citibank

Hi gentlemen. With regards to ARPU, it seems to be pretty disappointing with regards to subs. Do you like to like it going to be maintain the subs, can you get higher ARPU in subs and so where we’re going from here in July and August.

Amos Shapira

Can you repeat your question please.

Simon Marks – Citibank

Just with ARPU, it seems disappointing and you guys lost subs as well as it doesn’t seem like you’re maintaining subs for higher ARPU. What is going on here and does competition subside in July and August. What have you seen with regards to that?

Amos Shapira

About – because we are – about the subs and…

Simon Marks – Citibank

Yes.

Amos Shapira

Can you explain or rephrase your question?

Simon Marks – Citibank

Just ARPU seems to be very disappointing this quarter, I was just wondering what you are seeing there, what you’re seeing in July and August with regards to the competition?

Amos Shapira

I don’t – you know first of all, our ARPU is no surprise when – if we take into consideration what we announced before about expected impact of the interconnect and also other forecast that we gave. So I don’t know what this – what is the base of…

Simon Marks – Citibank

Is this – is this trend going to continue in terms of the competitive environment or where are we going from here?

Amos Shapira

No, I would not give any indication about the future. At the moment – at the moment the only thing is that we can explain the present or the past. We can’t and really we don’t know what will be the level of competition in the future. And so, I’m sorry that I can’t give you any more indication.

Simon Marks – Citibank

We are looking at what happened in July and August really, if you have any – if you can give us any indication to how it was.

Amos Shapira

No, the only thing – the only thing you know that is, is that what we wrote in our PR that we assume that the increased competition will continue to impact our future result, at least when we are looking at the close coming quarters, the third quarter or the fourth quarter. More than that, I can’t give you more indication from this.

Simon Marks – Citibank

Okay, okay. Thanks a lot.

Operator

The next question is from James Breen of William Blair. Please go ahead.

Louie DiPalma – William Blair

Hello, this is actually Louie DiPalma on behalf of Jim Breen. How are you guys?

Amos Shapira

Fine, thank you.

Louie DiPalma – William Blair

Hi. I have a follow-up question on capital expenditure, do you guys have appropriate capacity considering that your 3G subscribers are increasing at a fairly strong rate and the 3G subscribers likely have increased data usage relative to your overall subscriber base?

Amos Shapira

Now, without the limitation of seeing – looking to the future I would say that at least in the near future, let’s say in the coming one, two years we don’t see a serious threat that our network will be jammed. This is, as I’ve said, with the limitation of our ability to forecast the consumption. But if we continue with it – and we see and we experienced the rapid increase of data use. Now – and we take every measure that is possible in order to increase our capacity. Now my continuous investment and also by investment in increasing our network speed and as Yaacov said some minutes ago about the agreement with Nokia Siemens, this was exactly the purpose of this agreement.

And as we assume, we also are looking into the investment in LTE, but for the longer future the investment that we are doing today is what we call – what is called LTE Ready. Although the investment is to increase our quality of the network in what is called HSPA-DC, still this is the investment in LTE Ready. So when the government is going to free additional frequencies for the LTE, we shall be in a good position.

So as I’ve said hopefully the government will do it in the proper time, but in any case I don’t see that we are in a strategic threat regarding this issue as we look at it today.

Louie DiPalma – William Blair

Okay. And is your entire footprint covered by 3G now in terms of the network technology for all the cell site?

Amos Shapira

Can you say again, please.

Louie DiPalma – William Blair

Do all your cellular sites have 3G right now?

Amos Shapira

Most of our cell site are 3G.

Louie DiPalma – William Blair

Okay.

Amos Shapira

We have a five-year plan and we cover most of them with 3G coverage.

Louie DiPalma – William Blair

Excellent, thank you for taking the questions.

Amos Shapira

One thing more about the frequencies, as I say, we are not – we are not completely relaxed about this whether – for the future regarding issue of capacity. But as I’ve said, as we see it we are not under a strategic threat, and in a way when you compare us to our main competitor in the market, so we have a even advantage that we have more frequencies than our major competitor. So at least we are in a better position if not in a good position.

Louie DiPalma – William Blair

Great. Thank you very much.

Operator

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

Amos Shapira

Thank you everybody for joining Cellcom Israel’s second quarter 2011 earnings conference call. I look forward to hosting you again at our next call. Good day.

Operator

Thank you. This concludes the Cellcom Israel Ltd second quarter 2011 results conference call. Thank you for your participation. You may go ahead and disconnect.

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