Slow macro-economic recovery reflected in the underlying business trends

Budapest, May 6, 2011 00:00

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

Highlights:

• Magyar Telekom has introduced a new reporting structure from the beginning of 2011 following the introduction of its new management structure on July 1, 2010. The Group’s new operating segments are Hungary (which includes the former CBU, the SMB customers of BBU and the relevant parts of the Headquarters and Technology Units) and T-Systems (which includes the former BBU, without the SMB customers, that have been classified within Hungary, as well as the relevant parts of the Headquarters and Technology Unit). The Macedonia and Montenegro segments have not changed.
• Revenues were down by 3.3%, from HUF 147.4 bn to HUF 142.5 bn in the first quarter of 2011 compared with the same period in 2010. This was mainly due to lower fixed voice and internet revenues in Hungary together with a decline in mobile voice revenues in all three countries. These declines were partly offset by growth in TV and mobile internet revenues. The depreciation in the Hungarian forint had a slight positive effect on the revenue contribution from international subsidiaries (the forint weakened on average by 0.7% relative to the Macedonian Denar and by 1.0% relative to the Euro in the first quarter of 2011 compared to the same period in 2010).
• EBITDA declined by 7.7%, from HUF 57.7 bn to HUF 53.2 bn, with an EBITDA margin of 37.4%. Underlying EBITDA , which excludes investigation-related costs, severance payments and accruals, as well as the telecom tax, increased by 3.8% to HUF 61.5 bn. Underlying EBITDA margin was 43.1% in the first quarter of 2011 compared to 40.2% in the same period of 2010. The significantly higher EBITDA margin reflects the strong cost-cutting measures shown in employee related and other operating expenses, and a HUF 1.4 bn increase in gains on real estate sales in Hungary accounted for in other operating income.

• Magyar Telekom has been subject to special telecom tax introduced in Hungary in Q4 2010, charged on the companies’ annual revenues, retrospectively from January 1, 2010. As introduced in Q4 2010, this tax in 2010 only hit the Q4 results of both the Group and the segments. The presented EBITDA of the Hungarian segments (Hungary and T-Systems), however, now include the special telecom tax both in Q1 2010and Q1 2011 to allow a more reasonable comparison of the year-over-year performance of the segments. Q1 2010 Group numbers were not restated (in line with IFRS rules) making the Group’s year-over-year performance less comparable.
• Profit attributable to owners of the parent company ( net income) decreased by 7.8%, from HUF 16.4 bn to HUF 15.2 bn. The decline was driven by the EBITDA fall, partly offset by lower income tax. Income tax expense decreased from Q1 2010 to Q1 2011 as a combined result of  lower profit before tax and the still enacted reduction of the Hungarian corporate tax rate from 19% to 10% effective from 2013. There are a number of expenses (e.g. depreciation, amortization, FX losses) which are recognized at a corporate tax rate of 19%, while the related deferred tax expense at 10%. As long as this difference between the current (19%) and future (10%) enacted tax rates exists, it results in lower deferred tax expense reducing the effective tax rate.
• Net cash generated from operating activities increased from HUF 39.8 bn to HUF 44.6 bn. The lower EBITDA was counterbalanced by an improvement in working capital that wasmainly driven by the different timing of settlements with trade creditors throughout the year and lower income tax paid due to delayed advance payment of local business tax.
• Investment in tangible and intangible assets (CAPEX) decreased by HUF 3.4 bn to HUF 12.3 bn in the first quarter of 2011 compared to the same period in 2010. Of total CAPEX, HUF 9.8 bn related to the Hungary segment and HUF 0.4 bn to the T-Systems segment. In Macedonia and Montenegro, CAPEX spending was HUF 1.4 bn and HUF 0.4 bn, respectively.
• Free cash flow (operating cash flow and investing cash flow adjusted for proceeds from / payments for other financial assets) increased from HUF 19.0 bn in the first quarter of 2010 to HUF 27.0 bn in the same period of 2011. Operating cash flow increased by HUF 4.8 bn mainly driven by the improvement in working capital, while the lower CAPEX spending and the higher proceeds from real estate sales also supported the higher free cash flow.
• Net debt increased from HUF 265.4 bn to HUF 270.5 bn by the end of March 2011 compared to the end of March 2010 level. The net debt ratio (net debt to total capital) was 31.0% at the end of March 2011.

Christopher Mattheisen, Chairman and CEO commented: “Our performance during the first quarter this year reflects the slow macro-economic recovery we are experiencing. Looking at the Hungarian market, we continue to see promising signs with slightly higher consumer spending, increased mobile usage and lower churn both in the fixed and the mobile segment. However, strong competition and saturated core markets continue to put pressure on our business performance. Besides our continued focus on TV offerings and bundling, we have a new strategic initiative in the fixed voice segment. We launched a new flat fixed voice package at the beginning of this year called “Hoppá”. With this package all Hungarian fixed line and T-Mobile numbers can be called unlimited for a fixed monthly tariff. This unique offering in the Hungarian telecom market has already shown positive results: 15% of fixed customers have already migrated to the new package and 85% of these customers have signed a 2-year loyalty contract. Going forward, although in the short term the new package will cause a dilution in ARPU levels despite the already visible higher usage levels, in the longer term we expect a positive impact on fixed voice churn through these loyalty contracts. We have also managed to significantly decrease the ratio of residential 1Play customers from 63% to 55% in the preceding 12 months.
Revenues in the first quarter declined by 3.3% while underlying EBITDA was up by 3.8% compared to an extremely weak first quarter in 2010 when the operational performance of Magyar Telekom troughed. Although the results were also helped by real estate sales in Hungary, the savings in employee-related and other operating expenses clearly had a positive influence on our profitability. Excluding the real estate sales, underlying EBITDA still increased by 1.5%. Looking ahead, we reiterate our guidance and project a revenue decline of 3-5% and 4-6% underlying EBITDA decline for 2011. We intend to cut Capex by approximately 5% compared to last year’s spending.”

 

Hungary Segment

Revenues before inter-segment elimination fell by 3.4% to HUF 101.1 bn and EBITDA increased by 9.5% to HUF 38.3 bn in the first quarter of 2011 compared to the first quarter of 2010. The EBITDA margin grew from 33.4% to 37.9% driven by the lower employee related expenses and other operating expenses which was mainly due to efficiency improvements. These, coupled with lower levels of voice related payments, reflecting the lower traffic volume and the cut in the Hungarian mobile termination rates in December 2010 offset the decline in high margin voice revenues. The EBITDA increase was also driven by real estate sales in the first quarter of 2011 that generated a net profit of HUF 1.4 bn and accounted for within other operating income.Underlying EBITDA increased by 7.9% compared to the extremely weak Q1 2010 which was when the recession peaked. The underlying EBITDA margin was 44.0%.

• Fixed line revenues declined by 7.1% to HUF 45.0 bn in Q1 2011, driven by lower voice revenues as mobile substitution and migration towards IP-based solutions resulted in increased customer erosion, putting pressure on both average tariff levels and traffic volume. In addition, although the number of broadband customers continued to increase (nearly reaching 818,000), internet revenues decreased by 7.4% due to declining tariffs and migration towards lower priced packages. Growth in the TV customer base remained strong at 10.8% resulting in an increase in TV revenues of 13.5%. The number of total TV customers exceeded 751,000 by the end of March with growth driven mainly by the IPTV service, while demand for satellite TV also remained strong.
• Mobile revenues decreased by 0.2% to HUF 55.9 bn in the first quarter of 2011. The slight increase in the customer base, higher usage and the steady increase in the portion of postpaid customers successfully counterbalanced the unfavorable impact of lower effective tariff levels. T-Mobile remained the clear market leader and managed to increase its market share to 44.9% 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 13.0% thanks to the 48.0% increase in mobile broadband subscriptions supporting the growth in mobile Internet revenues. At the same time equipment and activation revenues grew by 19.3% driven by the increasing ratio of higher priced smartphone sales. Although the subsidies on these handsets are also higher, the total subsidy level decreased and the average acquisition cost per new customer was cut by 35.7%.

T-Systems Segment

Revenues before inter-segment elimination were down by 4.4% to HUF 28.1 bn while EBITDA decreased by 3.9% to HUF 3.9 bn in the first quarter of 2011. The EBITDA margin was 13.7%. Excluding special influences, underlying EBITDA was down by 3.1%, while the margin increased to 17.5%, reflecting the considerable efforts made to improve efficiency in light of the drop in high-margin voice revenues.

• Fixed line revenues were down by 8.5% to HUF 7.6 bn as business customers and the public sector reduced their telecommunications spending. Fixed line voice revenue erosion remained high, coupled with significant price pressure, which was also prevalent in other product categories. In addition, usage also declined driven by mobile substitution, resulting in 14.6% decline in voice retail revenues.
• Mobile revenues decreased by 5.4% to HUF 8.0 bn driven primarily by declining average tariff levels and lower levels of usage that could not be offset by an increase in our customer base. Furthermore, wholesale voice revenues were negatively affected by the cut in mobile termination fees effective from December 2010. Other mobile revenues declined due to the Governmental measures announced in August 2010. To preserve profitability, in addition to cost cutting measures, the acquisition cost per new customer was also cut by 27.1%.
• SI/IT revenues were down by 1.1% to HUF 12.4 bn in the first quarter of 2011. Whilst we face slightly increasing demand for SI/IT services in the corporate segment, the overall investment levels remained depressed due to the current economic environment and restrictive measures in the public sector.

Macedonia

In Macedonia, revenues decreased by 6.8% to HUF 17.1 bn in the first quarter of 2011 compared to the same period in 2010, with EBITDA increasing by 9.3%. The depreciation in the Hungarian forint had a slight positive effect on the revenue contribution from international subsidiaries (the Hungarian forint weakened on average by 0.7% compared to the Macedonian Denar in the first quarter of 2011 over 2010). The EBITDA increase was driven by two one-off items booked in Q1 2010: a provision of HUF 0.6 bn relating to a legal case and HUF 0.9 bn of other operating expenses in relation to the implications of the final report on the internal investigation. Stripping these one-off expense items out from the Q1 2010 figures, the underlying EBITDA declined by 6.8%, while underlying EBITDA margin remained flat at 54.2% reflecting the intense competition putting pressure on prices mainly in the mobile segment.

• Fixed line revenues were up by 2.2%. The increase in wholesale voice revenues, driven by growing incoming and transited traffic volumes and higher settlement prices charged for international traffic termination, offset the decline in voice retail revenues, while the growing demand for double and triple play packages resulted in higher TV revenues.
• Mobile revenues declined by 14.1% in a fiercely competitive environment. The significant reduction in both the prepaid and postpaid subscriber base and the competition-driven tariff reductions put pressure on revenues. Nevertheless, T-Mobile Macedonia remained the clear market leader with 49.9% market share, and beside the slightly improving 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, non-voice revenues declined due to promotions containing free and discounted SMS messages.

Montenegro

Revenues of the Montenegrin subsidiary decreased slightly by 1.2% to HUF 7.4 bn in the first quarter of 2011 compared to the same period in 2010, with EBITDA increasing by 3.4%. The FX changes (the Hungarian forint weakened on average by 1.0% against the Euro in the first quarter of 2011 compared to the same quarter in 2010) had a slight positive impact on the revenue contribution of our Montenegrin subsidiary. The increase in EBITDA was driven by cost cutting achievements. Underlying EBITDA increased by 3.4% and the underlying EBITDA margin improved from 36.2% to 37.9%.

• Fixed line revenues were down by 0.5% in the first quarter of 2011 as 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 packages. The voice wholesale revenue decline was driven by a significant migration of international traffic towards Serbia where that traffic is now transited by our competitors. On the other hand, both Internet and TV revenues increased considerably thanks to the strong growth in the number of ADSL and IPTV customers driven by the strong focus on bundled services.
• Mobile revenues declined by 2.7%. Although usage increased and the tariff levels were also slightly higher due to a more rational competitive environment, these could not offset the decline in the customer base resulting in a decline in voice retail revenues. Voice wholesale revenues also decreased driven by lower domestic traffic. These trends were to a degree offset by an increase in non-voice revenues, supported by the growing number of mobile internet users.

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 in Q1 2010. As segment results are prepared earlier than Group results, differences occur at times when certain items are booked after 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 0.9 bn 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 0.8 bn was included at Group level in Q4 2009, while at the Hungary segment (previously HQ) it was booked in Q1 2010.

Investigations into certain consultancy contracts

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.  

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 delivery 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. 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.  

As previously disclosed, the Company, through its external legal counsel, is engaged in discussions with the DOJ and the SEC regarding the possibility of resolving their respective investigations as to the Company through negotiated settlements.  The Company has not reached any agreement with either the DOJ or the SEC regarding resolution of their respective investigations, and discussions with both agencies are continuing. We may be unable to reach a negotiated settlement with either agency. Any resolution of the investigations could result in criminal or civil sanctions, including monetary penalties and/or disgorgement, against the Company or its affiliates, 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 programs.  The Company cannot predict or estimate whether or when a resolution of the DOJ or SEC investigations will occur, or the terms, conditions, or other parameters of any such resolution, including the size of any monetary penalties or disgorgement, the final outcome of these investigations, or any impact such resolution may have on its financial statements or results of operations. Consequently, the Company has not made any provisions in its financial statements as of March 31, 2011 with respect to the investigations. 

Magyar Telekom incurred HUF 0.4 bn expenses relating to the investigations in the first quarter of 2011, which are included in other operating expenses of the 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: Hungary (the home-related services brand T-Home and the mobile communications brand T-Mobile) and T-Systems (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.