Investor Releases

Interim management report – First quarter 2010 results

Economic difficulties continue to exert downward pressures

Budapest, May 12, 2010 00:00

Magyar Telekom (Reuters: NYSE: MTA.N, BSE: MTEL.BU and Bloomberg: NYSE: MTA US, BSE: MTELEKOM HB), the leading Hungarian telecommunications service provider, today reported its consolidated financial results for the first quarter of 2010, in accordance with International Financial Reporting Standards (IFRS).

Highlights:

  • Revenues were down by 7.5% to HUF 147.4 bn in the first quarter of 2010 compared with the same period in 2009. This was mainly due to lower fixed voice and data revenues in all three countries together with a decline in Hungarian mobile voice and SI/IT revenues. These declines were partly offset by growth in Hungarian mobile internet and TV revenues. However, the significant appreciation in the Hungarian forint resulted in lower revenue contributions from the international subsidiaries reflecting the translation impact (both the Macedonian Denar and the Euro weakened by 7.8% relative to the forint in the quarter compared to the same period in 2009).
  • EBITDA declined by 10.7% to HUF 57.7 bn, with an EBITDA margin of 39.1%.Underlying EBITDA, which is EBITDA excluding investigation-related costs (HUF 0.5 bn in Q1 2010 against HUF 1.7 bn in Q1 2009), as well as severance payments and accruals (HUF 1.0 bn in Q1 2010 against HUF 0.4 bn in Q1 2009) decreased by 11.1%. Underlying EBITDA margin was 40.2% in the first quarter of 2010 compared to 41.8% in the same period of 2009. Despite lower levels of voice related payments, reflecting the lower traffic volume and the cut in the Hungarian mobile termination rates, and the decrease in other operating expenses driven by our cost cutting initiatives, this was not sufficient to offset the high margin voice revenue decline. Furthermore, the strengthening of the Hungarian forint also had a negative impact when consolidating the EBITDA contributions from our foreign subsidiaries.
  • Profit attributable to owners of the parent company (net income) decreased by 23.6%, from HUF 21.5 bn to HUF 16.4 bn. The decline was primarily driven by lower EBITDA, only partly offset by lower net financial expenses due to a significant net foreign exchange loss experienced last year as opposed to a net foreign exchange gain in 2010. Overall, income tax increased as the abolishment of double deductibility of the local business tax in Hungary and the Macedonian tax law changes in 2009, which resulted in lower tax expenses in Macedonia in Q1 2009, were only partly offset by the lower tax base in the first quarter of 2010 and the removal of the solidarity tax in Hungary from this year on.
  • Net cash generated from operating activities decreased from HUF 50.5 bn to HUF 39.8 bn. The lower EBITDA was compounded by a deterioration in working capital, primarily due to differences in the timing of settlements with trade creditors throughout the year.
  • Investment in tangible and intangible assets (CAPEX) decreased by HUF 4.2 bn to HUF 15.7 bn in the first quarter of 2010 compared to the same period in 2009. Of total CAPEX, HUF 4.9 bn is related to the Consumer Services Business Unit, HUF 0.7 bn to the Business Services Business Unit, HUF 0.2 bn to Group Headquarters and HUF 7.0 bn to the Technology Business Unit, whilst in Macedonia and Montenegro, the CAPEX spending was HUF 1.9 bn and HUF 0.6 bn, respectively.
  • Net debt increased from HUF 217.8 bn to HUF 265.3 bn by the end of March 2010 compared to the end of March 2009 level. The significant increase was due to the strengthening of the forint between the two periods (by 13.9% compared to the Euro and by 14.1% compared to the Denar) which had a negative impact on the forint value of the cash held at our international subsidiaries. The net debt ratio (net debt to total capital) was 30.0% at the end of March 2010.


Christopher Mattheisen, Chairman and CEO commented: “In the first quarter of 2010, the substantial headwinds we experienced in the previous quarters driven by the economic downturn, strong competition and saturated core markets continued to put pressure on our business performance. Consequently, total revenues declined by 7.5%, primarily driven by decreasing voice revenues while underlying EBITDA was lower by 11% in the first quarter as our strict cost cutting initiatives could not fully offset the negative trends in voice services. Nevertheless, despite the unfavorable market conditions seen in the first quarter, we remain confident in our ability to improve our financial performance once the economic indicators which drive demand for our services start to show signs of recovery, which is expected towards the end of the year.
In the meantime, we continue to focus on strengthening our market positions and further improving operating and cost efficiencies by streamlining our organization. During recent months, not only did we maintain our leading core market positions, but we were able to increase our share of the mobile internet and TV market. Thanks to our attractive satellite TV and IPTV offerings, Magyar Telekom is now the second biggest pay-TV operator in Hungary. Going forward, our aim is to become the leader in this market.
Furthermore, we have recently announced a number of important changes to the Company’s organizational set-up aimed at improving further our operating and cost efficiencies. This will allow us to react with greater speed and effectiveness to changes in the market place and the wider economic environment. These initiatives, which will affect several areas of the Company, will also allow us to serve more efficiently the mass market segment, which makes up the majority of our revenues.”


Consumer Services Business Unit (CBU)

Revenues before inter-segment elimination fell by 4.0% to HUF 75.8 bn and EBITDA declined by 4.7% to HUF 44.4 bn in the first quarter of 2010 compared to the same period of 2009. EBITDA margin was broadly stable, as our disciplined efficiency improvement efforts offset the negative revenue impact. CAPEX amounted to HUF 4.9 bn in the first quarter with a significant proportion relating to the satellite TV operations.

  • Fixed line revenues declined by 5.2% in Q1 2010 compared to the same period in 2009. The decline was mainly driven by a decrease in voice revenues due to the high level of mobile substitution and migration to cheaper IP- and cable-based voice solutions. Besides the increased churn in our customer base, the above mentioned factors put pressure on traffic volume and average tariff levels. In addition, although the number of broadband customers continued to increase (now exceeding 617,000), internet revenues slightly decreased by 0.9%, reflecting the declining tariffs and the increased migration towards lower priced packages. The negative impacts were partially offset by the 18.0% growth in first quarter TV-related revenues, resulting from growth in the customer base. The number of total TV customers reached 678,000 by the end of March with growth mostly driven by the satellite TV service, while demand for IPTV also strengthened.
  • Mobile revenues declined by 3.0% to HUF 43.7 bn in the first quarter as the declining number of customers coupled with lower average tariff levels could not be offset by higher usage. At the same time, the 16% cut in mobile termination rates effective from January 2010 negatively impacted wholesale revenues. Although T-Mobile’s residential customer base decreased compared to the end-March 2009 level, this trend was driven mainly by the increased churn of inactive customers and cancellations of multiple SIM cards, thus T-Mobile still remained the clear market leader with a market share of 44.3% amongst active customers. At the same time, the mobile broadband market continued to expand, with the number of residential mobile internet customers increasing by 84.0%, to exceed 357,000.


Business Services Business Unit (BBU)

Revenues before inter-segment elimination were down by 7.7% to HUF 39.6 bn while EBITDA decreased by 7.4% to HUF 18.8 bn in the first quarter of 2010. Consequently, the EBITDA margin slightly increased from 47.2% to 47.4%, reflecting the considerable efforts made to improve efficiency in light of the revenue decline.

  • Fixed line revenues were down by 12.2% to HUF 11.2 bn reflecting the difficult macroeconomic environment, which led to a contraction in telecommunications spending. In the fixed line segment, revenue erosion accelerated as churn was high both among voice, data and internet customers. In addition, usage also declined driven by mobile substitution, resulting in an 18.0% decline in voice retail revenues.
  • Mobile revenues decreased by 4.9% to HUF 15.6 bn driven by the recessionary impacts and the intense competition. Consequently, churn remained high whilst average tariff levels and usage continued to decline in the first quarter of 2010. Although non-voice revenues increased thanks to the increasing usage of mobile broadband, and now represent 25.3% of corporate clients’ ARPU, overall ARPU was down by 10.3% in the first quarter compared to the same period last year. ARPU was also negatively affected by the cut in mobile termination rates effective from January 2010.
  • SI/IT revenues were down by 6.8% to HUF 12.7 bn in the first quarter of 2010. The decline was driven by lower investment levels, both at the private and the public sector, in response to the current economic environment. Furthermore, last year the first quarter results were positively impacted by higher outsourcing revenues predominantly due to a one-off sale of assets in a finance lease transaction.


Macedonia

In Macedonia, revenues decreased by 11.8% to 18.4 bn in the first quarter of 2010 compared to the same period in 2009, with EBITDA declining by 28.6%. Excluding the FX impact (the Hungarian forint strengthened on average by 7.8% to the Denar in the first quarter), revenues were down by 4.4% and EBITDA declined by 22.6%. EBITDA margin was down to 44.5% compared to 55.0% a year earlier, reflecting the intensifying competition putting pressure on prices both in the fixed and mobile segments, a one-off provision of HUF 0.6 bn relating to a legal case and the HUF 0.9 bn of other operating expenses booked in relation to the implications of the final report on the internal investigation.

  • Fixed line revenues declined by 11.2% in local currency terms, driven by intense competition from alternative operators and mobile substitution. These, coupled with the unfavorable economic environment, resulted in a further decline in outgoing traffic volumes and a high annual churn rate that exerted further pressure on voice revenues. On the other hand, the growing demand for double and triple play packages resulted in higher internet and TV revenues, which helped to mitigate the fixed revenue decline.
  • Mobile revenues were higher by 1.9% in local currency terms driven by a significant improvement in the customer mix. Although the overall customer base slightly declined by 1.4%, T-Mobile Macedonia recorded a 11.7% increase in the number of its postpaid customers driving the postpaid ratio up to 31.8% from 28.1% a year earlier. As a result, MOU significantly increased. However, the intense price pressure driven by the fierce competition somewhat limited ARPU growth opportunities. Consequently, ARPU in local currency terms showed a 4.7% rise in the first quarter of 2010 compared to the same period last year.


Montenegro

Revenues of the Montenegrin subsidiary were down by 9.4% to HUF 7.4 bn in the first quarter of 2010 compared to the same period in 2009 and EBITDA was also down by 35.6%. However, excluding the FX impact (the Hungarian forint strengthened on average by 7.8% against the Euro year-on-year), revenues declined by 1.7%, while EBITDA was down by 30.2%. The decline in EBITDA was driven principally by the headcount reduction-related severance expense of HUF 0.9 bn accounted for in the first quarter of 2010. Stripping that expense item out, EBITDA (in local currency terms) increased by 3.5% and the EBITDA margin improved from 34.4% to 36.2%.

  • Fixed line revenues declined by 1.6% in local currency terms in the first quarter of 2010 caused principally by lower retail and wholesale voice revenues that were only partly offset by increasing internet and TV revenues. The decrease in voice revenues was due to increased mobile substitution brought about primarily by significantly lower mobile tariffs following the entrance of the third mobile operator that intensified further the competitive environment.
  • Mobile revenues were down by 1.7% in local currency terms as the decrease in tariff levels could not be offset by the increased usage, resulting in declining mobile voice revenues. These trends were somewhat mitigated by the increase in non-voice revenues, supported by the growing number of mobile internet users.


Technology Business Unit

Technology Business Unit is a cost centre responsible for the operations and development of the mobile and fixed network as well as IT management. Network and IT related investments are also generated by this Business Unit. Revenues at the Technology Business Unit declined by 25.6% to HUF 2.0 bn while the EBITDA loss narrowed by 3.0% to HUF -10.9 bn. CAPEX amounted to HUF 7.0 bn in the first quarter of 2010, mainly driven by the rollout of the fiber-optic network and improvements made in the mobile broadband network.


Group Headquarters

Revenues before inter-segment elimination were down by 13.1% to HUF 28.8 bn. The revenue decline was mainly driven by lower wholesale revenues, especially within mobile revenues, reflecting the 16% cut in mobile termination rates since the beginning of 2010. EBITDA loss widened to HUF -6.2 bn, as the decline in revenues and increased other operating expenses related to overdue receivables could only be partly offset by the lower level of voice related payments.


Measurement differences

Please note that Group EBITDA is HUF 1.8 bn higher than the sum of segment EBITDAs in Q1 2010 due to two major items which were included in Group results in 2009, but have only been reflected in segment results this quarter. As segment results are prepared earlier than Group results, differences occur at times when certain items are booked once the segment results have been prepared. These are then immediately reflected in Group results, but are not included in segment results until the next financial period.
Due to the implications of the final report on the internal investigation, other operating expenses in the amount of HUF 891mn were booked in relation to the Macedonian subsidiary. While 2001-2006 results at Group level were restated to reflect this expense, at segment level it was booked only in Q1 2010. Consequently, Group level expenses in Q1 2010 do not include this expense. Secondly, a write-off on receivables in the amount of HUF 794mn was included at Group level in Q4 2009, while at the HQ segment level it was booked in Q1 2010.

In the course of conducting their audit of the Company’s 2005 financial statements, PricewaterhouseCoopers, the Company’s auditors, identified two contracts the nature and business purposes of which were not readily apparent to them. In February 2006, the Company’s Audit Committee retained White & Case, as its independent legal counsel, to conduct an internal investigation into whether the Company had made payments under those, or other contracts, potentially prohibited by U.S. laws or regulations, including the U.S. Foreign Corrupt Practices Act (“FCPA”) or internal Company policy. The Company’s Audit Committee also informed the United States Department of Justice (“DOJ”), the United States Securities and Exchange Commission (“SEC”) and the Hungarian Financial Supervisory Authority of the internal investigation.

Based on the documentation and other evidence obtained by it, White & Case preliminarily concluded that there was reason to believe that four consulting contracts entered into in 2005 were entered into to serve improper objectives, and further found that during 2006 certain employees had destroyed evidence that was relevant to the investigation. White & Case also identified several contracts at our Macedonian subsidiary that warranted further review. In February 2007, our Board of Directors determined that those contracts should be reviewed and expanded the scope of the internal investigation to cover these additional contracts and any related or similarly questionable contracts or payments.

For further information about the internal and governmental investigations, please refer to the Company’s quarterly reports for the first, second and third quarters of 2009 furnished under cover of Form 6-K and the Company’s annual reports on Form 20-F for the year ended December 31, 2009.

On December 2, 2009, the Audit Committee provided the Company’s Board of Directors with a “Report of Investigation to the Audit Committee of Magyar Telekom Plc.” dated November 30, 2009 (the “Final Report”).  The Audit Committee indicated that it considers that, with the preparation of the Final Report based on currently available facts, White & Case has completed its independent internal investigation. 

The Final Report includes the following findings and conclusions, based upon the evidence available to the Audit Committee and its counsel:
- The information obtained by the Audit Committee and its counsel in the course of the investigation “demonstrates intentional misconduct and a lack of commitment to compliance at the most senior levels of Magyar Telekom, TCG, and Makedonski Telekom during the period under investigation.” 
- As previously disclosed, with respect to Montenegrin contracts, there is “insufficient evidence to establish that the approximately EUR 7 million in expenditures made pursuant to four consultancy contracts ... were made for legitimate business purposes”, and there is “affirmative evidence that these expenditures served improper purposes.” These contracts were not appropriately recorded in the books and records of the Company and its relevant subsidiaries. As previously disclosed, the Company has already reclassified, in the Company’s financial statements, the accounting treatment relating to certain of these contracts to more accurately account for these expenditures.  
- As previously disclosed, there is evidence that certain former employees intentionally destroyed documents relating to activities undertaken in Macedonia by the Company and its affiliates.  
- Between 2000 and 2006 a small group of former senior executives at the Company and the Company’s Macedonian affiliates, authorized the expenditure of approximately EUR 24 million through over twenty suspect consultancy, lobbying, and other contracts (including certain contracts between the Company and its subsidiaries on one hand, and affiliates of a Cyprus-based consulting company on the other hand). The Final Report concludes that “the available evidence does not establish that the contracts under which these expenditures were made were legitimate.”
- “The evidence shows that, contrary to their terms, a number of these contracts were undertaken to obtain specific regulatory and other benefits from the government of Macedonia. The Companies generally received the benefits sought and then made expenditures under one or more of the suspect contracts. There is evidence that the remaining contracts were also illegitimate and created a pool of funds available for purposes other than those stated on the face of the agreements.”
- In entering into these contracts and approving expenditures under them, the former senior executives knowingly caused, structured, or approved transactions that shared most or all of the following characteristics:
     - intentional circumvention of internal controls;
     - false and misleading Company documents and records; 
     - lack of due diligence concerning, and failure to monitor performance of, contractors and agents in circumstances carrying a high risk of corruption;  
     - lack of evidence of performance; and  
     - expenditures that were not for the purposes stated in the contracts under which they were made, but rather were intended to obtain benefits for the Companies that could only be conferred by government action.  

The Final Report states that “the Investigation did not uncover evidence showing receipt of payments by any Macedonian government officials or political party officials.”  However, the Audit Committee’s counsel did not have access to evidence that would allow it to identify the ultimate beneficiaries of these expenditures. 

Nothing in the Final Report implicates any current senior executive or Board member of the Company in connection with any wrongdoing.

As previously disclosed, the Company has taken remedial measures to address issues previously identified by the independent investigation. These measures included steps designed to revise and enhance the Company’s internal controls as well as the establishment of the Corporate Compliance Program.  

Due to these measures, no modifications to the Corporate Compliance Program were viewed as necessary in response to the Final Report. This conclusion has been discussed with the Audit Committee and the Audit Committee has not made recommendations either relating to the Company’s compliance program or internal controls. 

The Company is continuing to assess the nature and scope of potential legal remedies available to the Company against individuals or entities that may have caused harm to the Company. 

As previously announced, the DOJ, the SEC and the Ministry of Interior of the Republic of Macedonia have commenced investigations into certain of the Company’s activities that were the subject of the internal investigation. Also, as previously announced, the Hungarian National Bureau of Investigation (“NBI”) has begun a criminal investigation into alleged misappropriation of funds relating to payments made in connection with the Company’s ongoing internal investigation and the possible misuse of personal data of employees in the context of the internal investigation. These governmental investigations are continuing, and the Company continues to cooperate with those investigations. The Company cannot predict what the final outcome of those investigations may be or the impact, if any, they may have on its financial statements or results of operations. Furthermore, government authorities could seek criminal or civil sanctions, including monetary penalties, against the Company or its affiliates as well as additional changes to its business practices and compliance programs. 

Magyar Telekom incurred HUF 511 million expenses relating to the investigation in the first quarter of 2010, which are included in other operating expenses of Group Headquarters.

About Magyar Telekom

Magyar Telekom is Hungary's principal provider of telecom services. It provides a full range of telecommunications and infocommunications (ICT) services including fixed line and mobile telephony, data transmission and non-voice as well as IT and systems integration services. The business activities of Magyar Telekom are managed by two business units: Consumer Services (the home-related services brand T-Home and the mobile communications brand T-Mobile) and Business Services (T-Systems brand). Magyar Telekom is the majority owner of Makedonski Telekom, the leading fixed line and mobile operator in Macedonia and it holds a majority stake in Crnogorski Telekom, the leading telecommunications operator in Montenegro. Magyar Telekom's majority shareholder (59.21%) is MagyarCom Holding GmbH, fully owned by Deutsche Telekom AG.

This investor news contains forward-looking statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore should not have undue reliance placed upon them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events.

Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors are described in, among other things, our Annual Report on Form 20-F for the year ended December 31, 2009 filed with the U.S. Securities and Exchange Commission.

In addition to figures prepared in accordance with IFRS, Magyar Telekom also presents non-GAAP financial performance measures, including, among others, EBITDA, EBITDA margin, underlying EBITDA, underlying EBITDA margin and net debt. These non-GAAP measures should be considered in addition to, but not as a substitute for, the information prepared in accordance with IFRS. Non-GAAP financial performance measures are not subject to IFRS or any other generally accepted accounting principles. Other companies may define these terms in different ways. For further information relevant to the interpretation of these terms, please refer to the chapter “Reconciliation of pro forma figures”, which is posted on Magyar Telekom’s Investor Relations webpage at www.telekom.hu/investor_relations.