Growth in underlying margins, reflecting continued focus on cost discipline

Budapest, August 4, 2011 00:00

Magyar Telekom (Reuters: MTEL.BU and Bloomberg: MTELEKOM HB), the leading Hungarian telecommunications service provider, has today reported its consolidated financial results for the first half of 2011, in accordance with International Financial Reporting Standards (IFRS).

Highlights:

• Revenues were down 3.9%, from HUF 297.8 bn to HUF 286.1 bn in the first half of 2011 compared with the same period in 2010. This was mainly due to lower fixed and mobile voice revenues in all three countries. In Hungary,  SI/IT revenues also declined. These declines were partly offset by growth in TV and mobile internet revenues. Appreciation of the Hungarian forint had a slightly negative effect on revenue contribution from international subsidiaries.
• EBITDA declined by 18.2%, from HUF 119.5 bn to HUF 97.8 bn, with an EBITDA margin of 34.2%. Underlying EBITDA , excluding investigation-related costs and provisions, severance expenses and the special telecom tax, increased by 0.8% to HUF 123.3 bn. The underlying EBITDA margin was 43.1% in the first half of 2011 compared to 41.1% in the same period of 2010. The higher underlying EBITDA margin reflects strong cost-cutting measures undertaken in employee-related and other operating expenditure, as well as a decrease in handset subsidies. In addition to this, Q1 2011 results were also supported by a HUF 1.4 bn gain on real estate sales in Hungary.

• Magyar Telekom has been subjected to a special telecom tax charged on the company’s annual revenues, retrospectively from January 1, 2010. As this was only introduced in Q4 2010, the impact of the tax was only seen in the Q4 results of both the Group and its segments in 2010 . However, the reported EBITDA of the Hungarian segments (Telekom Hungary and T-Systems Hungary) now includes the special telecom tax for both H1 2010 and H1 2011 to allow for a more accurate comparison of the year-on-year performance of the segments. H1 2010 Group numbers however, were not restated, (in line with IFRS rules), thereby making the Group’s year-on-year performance less comparable.
• On June 24, 2011 the Board of Directors of Magyar Telekom approved an agreement in principle with the staff of the U.S. Securities and Exchange Commission (the “SEC”) to settle its investigation relating to the Company. In light of this agreement in principle with the SEC and the ongoing negotiations with the Department of Justice (the “DOJ”), the Company recognized in Q2 2011 a provision of HUF 11.5 bn (USD 62.4 million) in connection with these investigations: of which HUF 1.1 bn was accounted for within the net financial results , with the rest accounted for within Other operating expenses in the Telekom Hungary segment.
• Profit attributable to owners of the parent company ( net income) decreased by 39.7%, from HUF 32.4 bn t o HUF 19.5 bn. This decline was driven by the fall in reported EBITDA and only partly offset by lower income tax. Income tax expense decreased in H1 2011 compared with H1 2010 due to a combination of lower profit before tax and a one-time booking of HUF 5.2bn in Q2 2010: this itself was due to a change in Macedonian tax law which calculates the corporate income tax payable based on the profit reserves expected to be paid out as dividends at a later date to non-resident entities.
• Net cash generated from operating activities increased from HUF 92.4 bn to HUF 95.5 bn. The lower reported EBITDA was more than offset by an improvement in working capital . This wasdriven by  the special telecom tax that was accounted for in the first half of the year but paid however, only in July (tax for the second half will be paid in October), provisions in relation to the agreement in principle with the SEC and a decline in bad debts.
• Investment in tangible and intangible assets (CAPEX) decreased by HUF 9.5 bn to HUF 26.7 bn in the first half of 2011 compared to the same period in 2010. Of this total number, HUF 21.3 bn related to the Telekom Hungary segment and HUF 1.2 bn to the T-Systems Hungary segment. In Macedonia and Montenegro, CAPEX spending was HUF 2.6 bn and HUF 1.4 bn, respectively.
• Free cash flow (operating cash flow and investing cash flow adjusted for proceeds from / payments for other financial assets) increased by HUF 10.4 bn in the first half of 2011 to HUF 63.8 bn from HUF 53.4 bn in the same period of 2010. Improvement in working capital led to a HUF 3.1 bn increase in operating cash flow. Lower CAPEX spending and higher proceeds from real estate sales also supported the higher free cash flow. §               
• Net debt decreased from HUF 297.4 bn at the end of June 2010 to HUF 295.1 bn by the end of June 2011. The net debt ratio (net debt to total capital) was 35.1% at the end of June 2011.

Christopher Mattheisen, Chairman and CEO commented: “Although we have been successful in our efforts to maintain or in some cases to even grow our market shares, the weakened Hungarian telecoms market and anemic recovery in the general economy caused the declining revenue trends to continue into the second quarter.  While we will maintain our efforts to increase revenue contribution from our growth services, this has not yet been able to offset declining fixed line and mobile voice revenues. Our focus on cost discipline continues to bear fruit and we were able to repeat our outstanding performance in the first quarter by delivering a 43% underlying EBITDA margin again in the second quarter.
We are, however, cautious on the second half of the year and expect the unfavorable economic environment to limit further household disposable income, while the competitive environment is also expected to strengthen as we approach the year end. Migration of subscribers to the Hoppá package continues to be strong; however, as indicated previously, the positive retention effect will be coupled with ARPA dilution for this year. Also, some of our expense lines are expected to show an increase in the second half, including employee-related expenses that will reflect wage increases implemented from July. Despite the slight growth in underlying EBITDA for the first half of this year, we maintain our guidance for an underlying EBITDA decline of 4-6% for 2011, although we now expect this decline to be towards the more optimistic end of this range. Our revenue target of a 3-5% decline and CAPEX reduction target of approximately 5% remain unchanged.”

 

Q2 2011 results analysis

Group

• Revenues declined by 4.6% in Q2 2011 compared to the same quarter in 2010. Retail voice revenues decreased across all markets, reflecting the unfavorable economic environment and intensifying mobile competition in Macedonia. Lower Hungarian mobile termination rates introduced in December 2010 resulted in a wholesale mobile revenue decline which could not be offset by the increase in TV and mobile broadband revenues.
• Reported EBITDA was down by 27.9% in the second quarter, while underlying EBITDA declined by 2.1%. This EBITDA decline was a direct result of lower revenues and could not be wholly offset by the cost cutting initiatives which were undertaken primarily in employee-related expenses and other cost items such as marketing and consultancy expenses. However, underlying EBITDA margin still showed an increase from 42.0% in Q2 2010 to 43.0% in Q2 2011.

Telekom Hungary Segment

Revenues before inter-segment elimination fell by 3.2% to HUF 104.0 bn, EBITDA was down 26.1% to HUF 27.7 bn and EBITDA margin was 26.7% in the second quarter of 2011. Excluding special influences, which mainly includes the special telecom tax and the investigation-related costs and provisions, underlying EBITDA was down by 1.0% to HUF 44.0 bn in the second quarter of 2011 compared to the second quarter of 2010. The underlying EBITDA margin grew from 41.4% to 42.3% driven by a reduction in employee-related expenses and other operating expenses largely as a result of efficiency improvements. These reductions, coupled with lower levels of voice related payments, mainly reflecting a cut in Hungarian mobile termination rates in December 2010, almost fully offset the decline in high margin voice revenues.

• Lower voice revenues as a result of mobile substitution and migration towards IP-based solutions, coupled with the dilution impact of Hoppá packages, caused fixed line revenues to decline by 5.6% to HUF 45.2 bn in Q2 2011. The decline in fixed line internet revenues narrowed to -2.6%, while growth in TV revenues remained strong at 13.9%. The total number of TV customers exceeded 756,000 by the end of June, with strong migration from cable TV to the IPTV service.  Demand for satellite TV also remained strong.
• Mobile revenues decreased by 1.3% to HUF 58.5 bn in the second quarter of 2011. A slight increase in the customer base, higher mobile usage and a steady increase in the proportion of post-paid customers could not fully offset the unfavorable impact of lower effective tariff levels. As such, retail revenues were down by 2.0%. However, T-Mobile remained the clear market leader and managed to increase its market share to 45.1% amongst active customers. Voice wholesale revenues were hit by a 16% cut in mobile termination fees, effective from December 2010. Non-voice revenues grew by 9.7% as a result of a 52.8% increase in mobile broadband subscriptions that supported the growth in mobile internet revenues. Driven by an increasing ratio of higher priced smartphone sales, equipment and activation revenues grew by 6.0%. Although subsidies on these handsets are also higher, the total subsidy level decreased and the average acquisition cost per new customer was cut by 24.6%.

T-Systems Hungary Segment

Revenues before inter-segment elimination were down 9.8% to HUF 26.2 bn. EBITDA was up 6.5% to HUF 4.4 bn in the second quarter of 2011 and the EBITDA margin was 16.9%. Excluding special influences, which mainly includes the special telecom tax, underlying EBITDA declined by 5.5% to HUF 5.4 bn. The underlying EBITDA margin of 20.6%, up from 17.6% in the second quarter of 2010, reflected efforts to improve efficiency in light of the drop in high-margin voice revenues; the level of bad debts also significantly improved after the settlement of some outstanding bills in the public sector.

• Fixed line revenues were down 6.3% to HUF 7.5 bn driven by lower usage and continued erosion in our customer base, principally caused by mobile substitution, coupled with significant price pressure. Voice retail revenues declined by 10.3%.
• Mobile revenues decreased 4.6% to HUF 8.3 bn, driven primarily by declining average tariff levels and lower levels of usage that could not be offset by the increase in customer base. Other mobile revenues declined due to the Governmental measures announced in August 2010. To preserve profitability, in addition to other cost cutting measures, the acquisition cost per new customer was cut by 21.2%.
• SI/IT revenues were down 15.6% to HUF 10.5 bn in the second quarter of 2011. Due to restrictive measures imposed by the government, no new public IT deals have been launched in the last several quarters, while earlier mandated projects are coming to an end. In addition to this, demand for SI/IT services in the corporate segment has not yet recovered to pre-recession levels, due to the ongoing difficult economic environment.

Macedonia

In Macedonia, revenues decreased by 13.1% to HUF 17.0 bn in the second quarter of 2011 compared to the same period in 2010, with EBITDA down 17.3%. The appreciation of the Hungarian forint had a slight negative effect on revenue contribution (on average, the Hungarian forint strengthened by 2.7% against the Macedonian Denar in the second quarter of 2011 compared with 2010). The EBITDA decline is due to the intense competition within mobile, resulting in significant pricing pressure and increasing level of handset subsidies: both these factors could not be offset by decreasing other operating expenses.

• Fixed line revenues were down 8.3%. The increase in wholesale voice revenues, which was driven by growing incoming and transited traffic volumes and higher settlement prices, could not offset the strong decline in voice retail revenues. Growing demand for double and triple play packages resulted in higher TV revenues.
• Mobile revenues declined by 17.0% due to the fiercely competitive environment in Macedonia. The decline in the pre-paid subscriber base as well as competition driven tariff reductions put pressure on revenues. Nevertheless, T-Mobile Macedonia remained the clear market leader with a 50.0% market share.  In addition to the slightly improved customer mix, the more widely used closed user group offers resulted in higher MOU. However, despite the increase in mobile internet usage and the higher number of SMS messages sent, non-voice revenues also declined due to promotions offering free and discounted SMS messages.

Montenegro

Revenues of the Montenegrin subsidiary stayed flat at HUF 7.8 bn in the second quarter of 2011. FX changes (on average, the Hungarian forint strengthened by 2.6% against the Euro in the second quarter of 2011 compared to the same quarter in 2010) had a slight negative impact on revenue contribution from the Montenegrin subsidiary. EBITDA increased by 14.5% to HUF 3.3 bn and the EBITDA margin improved from 36.6% to 41.8%. The increase in EBITDA was driven by lower employee related expenses after the headcount reduction in Q1 2011, further cost cutting achievements and improved debt collection.

• Fixed line revenues were down 3.3% in the second quarter of 2011. Higher internet and TV revenues were offset by lower retail and wholesale voice revenues. The decrease in retail voice revenues was due to increased mobile substitution and discounts offered in flat-rate packages. The voice wholesale revenue decline was driven by a significant migration of international traffic towards Serbia where it is now transited by competitors. However, both Internet and TV revenues increased considerably as a result of strong growth in the number of ADSL and IPTV customers which was driven by a strong focus on bundled services.
• Mobile revenues were up 3.7% due to a revenue reversal in Q2 2010 that related to a fraud case. Excluding this EUR 0.8 million one-off impact, revenues were down by 2.5%.  Voice retail revenues declined due to a lower pre-paid customer base and lower post-paid ARPU. Voice wholesale revenues decreased due to lower domestic traffic whilst non-voice revenues increased as a result of the growing number of mobile internet users.

Investigations into certain consultancy contracts

As previously disclosed, the Company’s Audit Committee conducted an internal investigation regarding certain contracts relating to the activities of the Company and/or its affiliates in Montenegro and Macedonia that totaled more than EUR 31 million. In particular, the internal investigation examined whether the Company and/or its Montenegrin and Macedonian affiliates had made payments prohibited by U.S. laws or regulations, including the U.S. Foreign Corrupt Practices Act (the “FCPA”). The Company has previously disclosed the results of the internal investigation. For further information regarding the internal investigation, see the Company’s annual report for the year ended December 31, 2010. 

The United States Department of Justice (the “DOJ”), the United States Securities and Exchange Commission (the “SEC”) and the Ministry of Interior of the Republic of Macedonia commenced investigations into certain of the activities that were the subject of the internal investigation. Further, in relation to certain activities that were the subject of the internal investigation, the Hungarian Central Investigating Chief Prosecutor’s Office has commenced a criminal investigation into alleged corruption with the intention of violating obligations in international relations and other alleged criminal offenses. In addition, the Montenegrin Supreme State Prosecutor is also investigating the activities of the Company that were the subject of the internal investigation and has requested information from the Company in relation to the relevant contracts. These governmental investigations are continuing, and the Company continues to cooperate with these investigations. 

On June 24, 2011, Magyar Telekom announced that its Board of Directors had approved an agreement in principle with the staff of the SEC to resolve the SEC’s investigation of the Company’s possible violations of the FCPA through a settlement. Pursuant to the agreement in principle, the Company, without admitting or denying the allegations against it, would consent to a U.S. court order permanently enjoining it from any future FCPA violations and pay disgorgement and a conditional civil penalty. The agreement in principle reflects the SEC staff’s consideration of the Company’s self-reporting, remediation and cooperation with the SEC’s investigation. The agreement in principle is not a final settlement of the SEC’s investigation and the terms of any final settlement would be subject to final approval by the Company’s Board of Directors, the SEC and a U.S. District Court.  

The Company continues to engage in discussions with the DOJ regarding the possibility of resolving the DOJ’s investigation of the Company through a negotiated settlement. The Company may be unable to reach a negotiated settlement with the DOJ. Any resolution of the DOJ investigation could result in criminal sanctions, including monetary penalties, which could have a material effect on the Company’s financial position, results of operations or cash flows, as well as require additional changes to its business practices and compliance program. The Company cannot predict whether or when a resolution of the DOJ investigation will occur, or the terms, conditions, or other parameters of any such resolution.  

In light of the agreement in principle with the SEC staff, and the ongoing negotiations with the DOJ, the Company has recognized a provision of HUF 11.5 bn (USD 62.4 million) in connection with these governmental investigations in the second quarter of 2011. However, the amount of any payment obligation upon final settlement or other resolution of these investigations may differ from the amount of the provision. 

In addition to the provision, Magyar Telekom incurred HUF 0.6 bn expenses relating to the investigations in the first half of 2011, which are included in other operating expenses of the Telekom Hungary segment.

 

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 Hungarian business activities of Magyar Telekom are managed by two segments: Telekom Hungary (the home-related services brand T-Home and the mobile communications brand T-Mobile) and T-Systems Hungary (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, 2010 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.