Bezeq The Israel Telecommunication Corp. Ltd (BEZQ) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Bezeq Second Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded and broadcasted over the web. At this time, I would like to turn the call over to Mr. Naftali Sternlicht, Investor Relations Manager for Bezeq. Mr. Sternlicht, please go ahead.

Thank you, operator. Welcome, everyone, and thank you for joining us on the call today. With us from Bezeq Group's senior management team, we have Mr. Gil Sharon, Bezeq's incoming Chairman; Mr. David Granot, Bezeq's Interim Chairman; Mr. Dudu Mizrahi, Bezeq Fixed-Line CEO; Mr. Ran Guron, CEO of Pelephone, Bezeq International and yes; and Mr. Yali Rothenberg, Bezeq Group's Chief Financial Officer. Before we start, I would like to draw your attention to the safe harbor statement on Slide #2, which also applies to any statement made during today's call. The speakers' comments will generally follow the slide presentation, which is available under the Slides tab on the webcast link and may also be downloaded from Bezeq's IR website. You can go through the presentation by clicking on the arrows on the left- or right-hand side. Let me now turn the call over to our incoming Chairman, Mr. Gil Sharon; and Interim Chairman, David Granot for prepared remarks. Yali will then continue the presentation on group financial highlights, followed by Dudu discussing Bezeq's Fixed-Line results. Ran will pick up with results of our subsidiaries, and Yali will wrap up the presentation, after which management will be available to answer questions.

Thank you, Naftali. Let me start by introducing myself. My name is Gil Sharon, and I'm happy and excited to join Bezeq Group soon. I'm 56 years old. I have over 25 years of experience in telecom, of which 10 are or were as CEO of Pelephone. Bezeq is the largest and most significant telecommunications group in Israel, and we stand at the dawn of a new era to lead Israel to the next-generation networks with the upcoming launch of the ultrafast communication network, the fiber optics network and the 5G cellular network. These are exciting opportunities for the group. After having been a part of the group for some 14 years, it gives me great honor to be back at Bezeq at this exciting time and to lead us forward. Now I will turn the call over to David to begin with prepared remarks on COVID-19 pandemic situation and its impact on Bezeq business.

Thank you, Gil. It gives me great pleasure to welcome you back to Bezeq group and wish you all the success. Let's start on Slide 3. Since the outbreak of the COVID-19, the group companies have been working hard to maintain operational continuity to provide services to our business and private customer and enable them to carry on with what they needed to do while complying with the government guidelines. In addition, the group companies have taken steps to deal with the risk arising from the pandemic, including lowering expenses and adjusting their operation according to the situation. Overall, as of the end of the second quarter of 2020, the total impact of the pandemic on the financial condition of the group companies was immaterial. Let me remind you that Bezeq and the telecommunication company as a whole belong to the infrastructure sector, which is deemed as essential sector by the government and the public and the private sector continue to rely heavily on the company's services in such event. Demand for some of the services provided by the company has really grown as a result of the regulatory measure imposed due to the pandemic. In terms of opportunities, as more people spend more time indoors, we are seeing an increase in retail Internet lines, in traffic -- lines of traffic, increasing the fixed line telephone usage as well as growing demand for content services. In the business sectors, we are seeing growth in the demand for remote connection and virtual conference. While we proactively capture this market opportunity, we also continue to push forward with streamlining initiatives to cut cost. In terms of challenges from the pandemic, you can see on Slide 4 that there was primarily a decrease in revenues from the Pelephone roaming services due to reduced air travel as well as some decrease in the revenues from the business sectors across the group companies. Real estate sales may be postponed based on the market condition. And while we anticipate a possible rise in doubtful debts, we estimate that the company's robust balance sheet, cash generating capacity and ready access to the capital market will enable us to adequately deal with any potential negative effects. Now I will turn the call to Yali to talk about our financial results. Yali, please.

Thanks, David. Turning to Slide 6. The group's strong financial results in the second quarter validate the strength of the group operations, the diversification of sources of revenue and the ability to streamline expenses. During the quarter, group-wide revenues totaled ILS 2.16 billion, down 3.1% from the prior year quarter. The decrease in revenues was due to lower revenue in the key subsidiary companies, partially offset by an increase in revenues in Bezeq Fixed-Line. On Slide 7, group-wide gross salary expenses decreased from ILS 489 million a year ago to ILS 444 million in the second quarter of 2020, a decrease of 9.2%. The decrease was due to the reduction in the number of employees and associated salary expenses in all key group business segments. Meanwhile, group-wide operating expenses decreased from ILS 814 million a year ago to ILS 753 million in the first quarter of 2020, a decrease of 7.5%. The decrease in operating expenses was due to a reduction in expenses in Bezeq International and yes. Salary and operating expenses were also impacted by the effect of the pandemic in the second quarter of 2020. Turning to Slide 8. Adjusted EBITDA in the second quarter of 2020 was ILS 958 million compared to ILS 921 million in the same quarter of 2019, an increase of 4%. The increase was mainly attributable to an increase in Bezeq Fixed-Line and yes. Group-wide adjusted net profit increased 13.5% to ILS 253 million in the first quarter from ILS 223 million a year ago. Moving to Slide 9. Free cash flow in the second quarter was ILS 144 million compared to ILS 350 million in the same quarter of 2019. The decrease in free cash flow was mainly due to net proceeds received of ILS 174 million relating to the sale of the Sakia complex in the corresponding quarter of 2019. After adjusting for the impact from Sakia, free cash flow was down 18.2% year-over-year due to changes in working capital. Gross CapEx in the second quarter amounted to ILS 351 million compared to ILS 525 million in the same quarter a year ago. The decrease was mainly due to the sale of the Sakia complex. After adjusting for the impact from Sakia, gross CapEx was down 6.6% mainly due to yes' migration to IP broadcasting. On Slide 10, we have broken down subscribers and ARPU by different business segments. Let me point out that subscribers in cellular, retail broadband and TV segment moved up during the quarter. And telephony ARPU grew to ILS 51 compared to ILS 49 in the second quarter of 2019. Lastly, turning to Slide 11. We are adapting operations to evolving market conditions and continue to improve our debt profile. Of particular note, this past quarter, in the year-on-year decrease -- with the year-on-year decrease of ILS 900 million in net debt as well as the decrease in net debt-to-EBITDA leverage ratio from 2.5 in Q2 2019 to 2.3 in Q2 2020. In addition, we continued to repay debt this quarter with the arrear repayment of a ILS 500 million loan and a capital raise of ILS 724 million in long-term debt. Now Dudu will share with you updates on the Fixed-Line operations.

Thanks, Yali. I'm pleased to share that we posted strong financial results in the second quarter and, for the first time in 2 years, recorded an increase in revenues. The increase in revenues was attributable to growth in the private and business broadband sector as well as cloud and digital services. At the same time, for the first time in 5 years, we recorded an increase in the number of retail broadband subscriber, as you can see on Slide 13. In addition, we also grew total broadband lines while continuing to accelerate the sales of related equipment. On the next slide, in terms of progress in regulatory issues, we have positive news to share. The Ministry of Communication approved the use of B35 technology which enables broadband speeds of up to 200 meg. We also received a permanent automatic extension of the reverse bundle offering. Most importantly, on fiber deployment, there has been significant progress in the regulatory efforts to approve Bezeq's fiber optic outline and will soon be submitted to the government for approval. Our entry into the field of fiber optics will have far-reaching effects on Bezeq and the entire Israeli economy and it will enable millions of customers throughout Israel to enjoy ultrafast broadband and make the State of Israel a world leader in telecommunication infrastructure. Turning to Slide 15. We continue to focus on the customer premises through a three-part strategy, which consists of our BE router as a base, home product that ensure broadband quality such as BSPOT and MESH and value-added services such as cyber protection, antivirus and network support. The number of customers with the BE router increased from 215,000 in the second quarter of 2019 to 433,000 in the second quarter of 2020. About 44% of our retail customers choose to connect with the BE router. Meanwhile, the number of customers with BSPOT or Be Mesh increased by 129% over the same period. Turning to the next slide. We recently launched our new Smart Home service, which enables a wide variety of capabilities based on Bezeq BE router and strengthen our customer premise strategy. The system comes with 5 components, which together brings an elevated smart living experience to our customers. Moving on to Slide 17. Our retail ARPU continued to grow as a result of increased penetration in customer premises services as well as value-added services. This is still the only telecommunication product in Israel that has consistently shown ARPU growth. On Slide 18, our telephone offering saw significant increase in traffic during the quarter with outgoing minutes up 25% year-over-year and incoming minutes up 22% year-over-year. As a result, telephony revenues increased by ILS 10 million compared to the previous quarter and access line churn slowed down. Turning to the next slide. In addition to telephony, we saw revenue growth in the transmission and data, cloud and digital services and other segments. Revenues for the transmission and data segment was up 5.5% year-over-year due to an increase in high-speed Internet services for business customers as well as transmission services for ISPs. Revenues for the cloud & digital segment was up 2.9% year-over-year due to an increase in virtual exchange and cloud services for businesses. Revenues for other segment was up 16.6% year-over-year due to an increase in sales of cellular equipment. Moving to Slide 20. In addition to retail, we are leading the business sector through advanced telecommunications solutions supported by high-quality infrastructure. As COVID-19 persists, the ability for businesses to operate remotely and continue to provide services remain critical. Toward that end, we stepped up our offering of video conferencing and remote access solution to businesses in addition to virtual exchange and other IT solutions. Moving to Slide 21. Revenues in the second quarter were ILS 1.04 billion compared to ILS 1.02 billion in the previous -- in the prior year quarter. The increase in revenue was due to an increase in most revenue items, which was partially offset by a moderate decrease in revenues from telephony services. Meanwhile, expenses were up slightly from last year, mainly due to an increase in operating expenses, which was impacted by an increase in interconnect fees to several operators. Turning to Slide 22. Adjusted EBITDA in the second quarter was ILS 680 million compared to ILS 656 million in the same quarter of 2019. Meanwhile, adjusted net profit decreased by 3.8% year-over-year to ILS 227 million, mainly due to an increase in financing expenses resulting from the early repayment of debt. After adjusting for the early repayment, adjusted net profit rose by 12.7%. Now I'll turn to Ran -- the call to Ran to talk about Bezeq's subsidiaries.

Thanks, Dudu. This quarter, we can see the subsidiaries companies are profitable, generate positive cash flow and are steadily increasing the number of subscribers. The company has proven the strength and stability during COVID-19 with fast and accurate operation as well as proper management of expenditure. At the same time, the company has continued to work to ensure the best service and network experience for the customers. We will be the first to launch 5G service in Israel. We are progressing with the transition of IP broadband broadcasting in yes, and Bezeq International continues to lead the business service and develop real-time solution for private and business customers. Clearly, the subsidiary companies are showing significant results. Moving to Slide 24. I'd like to remind everyone that all of this started in early 2019 when we took one of the -- when we took on the challenge and merged not 2 but 3 companies, Pelephone, Bezeq International and yes, to realize synergies and operational efficiencies. We are currently going through Phase A, which runs from 2019 to 2021, and with Phase B starting in 2022. Going forward, our goals in Slide 25 are to promote customer solution, lower expenses, improving financial and operational metrics, streamline operations, enhance customer benefit and create synergies. Moving to Slide 26. The key organizational process that we have already began in order to achieve those goals include appointing a unified management team to streamline the decision-making process, implementing joint procurement to save operating expenses and continue to sign synergy and streamline agreements with the 3 companies to reduce headcount. Some additional areas we are targeting for the future savings are in Slide 27 and include savings in real estate expenses by moving corporate headquarters, saving in transition from purchasing of expensive set-top boxes to cheaper streamers and saving in investment and cost of support through switching to one CRM system. At the end of the day, we are undertaking all those initiatives to benefit our customers and so they can have a wide range of triple play and quad offers, centralized billing services, original content and so on. Toward this end, in Slide 28, I'm pleased to share that all 3 subsidiaries companies are marching on to offer next-generation of technologies in each of 3 business units: 5G in mobile, IP in yes and Bezeq International use Bezeq's optic fibers. Moving to Slide 21 -- 29 for yes, our IP migration is bringing enhanced customer experience as well as cost savings. Customers have access to most robust content library in Israel in both Android and Apple TV. We recently launched yes+ LIVE, a ground-breaking technology for watching broadcast truly live without any delay. So far, 15% of our customers have at least one IP streamer and we are saving money in doing so as we replace expensive set-top boxes in cheaper streamers. Moving to Slide 30. The success of IP migration is manifesting itself through increase in subsidiaries and improved financial metrics. yes reported net profit in the first half of the year and growth of free cash flow year-over-year while increasing the number of subscribers for the second consecutive quarter. Moving to Slide 31. For Pelephone, we continued to grow our subscriber base during the quarter and during the first half of the year. In Slide 32, upon winning the government 5G tender auction, we are excited to launch 5G service with record speed, wide coverage access and diverse selection of handsets and plans. I would like to emphasize that Pelephone is the only company that won frequencies for its exclusive use, which will give competitive advantage to Pelephone network. Moving to Slide 33 and 34 for Bezeq International. We are bringing innovative solution for home and businesses with the launch of our new router, WiFi +, MESH support system and remote connection. We've been a leader in business solution and the pandemic led to further increase in corporate demand for larger bandwidth based on our Internet infrastructure. Turning to Slides 35 to 37. Let's briefly look at some financial metrics for subsidiary companies. We continue to lower salary expenses during the quarter. Since the first quarter of 2018, salary expenses decreased by 26%. Revenues went down slightly year-over-year due to the decrease in roaming revenues as a result of the pandemic. Expenses declined across broad due to streamlining initiatives. Adjusted EBITDA and adjusted net profit decreased year-over-year due to the pandemic impact on roaming revenues, which are partly offset by measures to adjust expenses as well as increased demand for other products of the companies. I would now turn the call back to Yali, who will update you on the group's 2020 outlook.

Thanks, Ran. Previously, we suspended providing guidance due to the outbreak of COVID-19 and the resulting uncertainty in the global and local economy. Although the uncertainty in the economy remains high, we decided to publish our outlook for 2020 based on current information and after a review of the group's performance during the pandemic. We expect adjusted net profit to be ILS 950 million, adjusted EBITDA to be ILS 3.5 billion and CapEx to be ILS 1.5 billion. Let me remind you that we will be holding a virtual analyst conference in Hebrew for the local market after this call. In addition, we will be hosting virtual investor meetings this week on August 19 and 20 with Jefferies, and we will be participating in virtual investor meetings through the Barclays Media and Telecom Forum on September 3. This concludes our prepared remarks. Operator, let's begin the Q&A session.

[Operator Instructions] The first question is from Tavy Rosner of Barclays.

This is Chris Reimer on for Tavy. Could you give us some more color on what Phase 2, the cost-cutting, includes and specifically, where it relates to employee agreements and early retirements? I think the last agreements were in the scope of 325 for each International and yes and then 400 at Pelephone. If you could tell us how many more could potentially be beyond that and if any new contracts for the following years would be in the same scope. Or would they be smaller?

Ran, this is for you, seems for Phase 2.

Okay. So first phase of the alpha plan is supported by agreements with the unions until the end of 2021. So we have streamlined 1,000 employees so far, and there are hundreds more to go supported in the current agreement. We will negotiate new agreements during the year of 2021 for the years 2022 henceforth. This, of course, will not be -- the numbers will not be the same because the streamlining process is -- we are pushing it forward, but it cannot be the same numbers, of course. We will not give any numbers right now, but we are now in the middle of the process of preparing the next phase for alpha.

Okay. And then on the fiber side, you mentioned the significant regulatory progress, which was achieved during the quarter. Looking forward, what are the last regulatory issues which need to be solved before you can turn on the network?

This is Dudu. I think there are 2 main issues still pending. One is, of course, the government decision regarding universal service obligation. The second is the wholesale regime for the fiber. And I think at least we expect those 2 issues to be resolved during the very near future.

Okay. And one last question for Yali if I may. Regarding the guidance, you delivered already close to ILS 1.9 billion in adjusted EBITDA for the first 6 months. So looking at the ILS 3.5 billion guidance, I'm wondering if you're being conservative or if you're expecting a slowdown maybe in the second half.

So Chris, as mentioned, we've decided to give the outlook given the current market uncertainty. Some of the trends might end up better or worse than we expected, telephony, for example, while some may -- while during the first -- also during the first half of the year, we've also enjoyed cost-cutting, specifically, for example, city taxes, fuel cost, salaries and other expenses. Some of these expenses will be saved also in the second half. Nonetheless, we will be happy to overperform and do better than our guidance.

The next question is from Stephen Levey of Ion.

Just 2 questions from me. Just a follow-up on the regulatory stuff. Just some clarification. If we don't get a budget passed over the next few weeks, if the government doesn't survive what's been going on, will you guys be waiting for the next government and for a budget to be passed in 2021 before you start the fiber rollout? Or is there any plan to actually begin that even without the budget passing?

Stephen, currently, we are waiting for the government decision, as I mentioned, but we are looking at other possibilities if and when such a decision will not be made. So there are different option. I'm not going to get into them right now, but there are options.

If the government collapse, there is a -- there will be an interim government. And this interim government also can pick up the decision regarding the cyber. So it is not the end of the world. And we believe that within week or 2 we'll get this governmental decision.

It does sound though, from a nuance perspective, there's a slight change in approach here because previously I think it had been made quite clear from management that there will be no rollout without the final government approval. But what you're saying, if I understand correctly, is that you are open to other possibilities should the approval not come in the very short term. Is that fair?

I think, Stephen, we still think that the option of getting the government decision is, of course, our primary goal. But since you've asked, we are looking at other options whether that small possibility will happen and there will no government decision, I think there's still options that we can move forward even without the government decision. But we think now that the -- what the Ministry of Communication and Finance is trying to do is to get this government decision. It's purely technical issue right now. So we believe we'll get that decision very soon.

Okay. Second question maybe, there's a few mentions of 5G across the presentation that you just went through. The one thing that I didn't really notice was any kind of clear feeling in terms of timing. Do you want to give us a sense of when you're going to have an operational 5G network up and running?

Ran, this is for you.

Yes, this is Ran. 5G network is operating. We need to -- need the MOC to allocate the frequency, which is -- should be done in a few short weeks. But the core network, partially radio system, handsets and plans are in order. So from our point of view, the network is fully operational. Of course, full deployment will take a few years because it's not done in 1 single year, but we are ready for the tenders. So we are waiting to get the frequencies that we have won in the auction.

No, I understand that. I was, from my understanding, looking how these things roll out globally, the amount of work that needs to go in new base stations that needed to be added. What I'm asking is when will you have a fully operational national 5G network running in Israel. Is it a 2021 event? 2022? 2023? Just give me a rough idea of when there'll be a fully operational network.

Sure. We will not give accurate information about that. But typically, to cover this country takes 4 to 5 years in any kind of technology, 4G, 5G cover each one of all the base stations. So this can give you a general time frame for that.

So we shouldn't really be factoring anything in terms of 5G, in terms of any potential increase in revenues at any point over the next 3 years, significantly anyway?

Well, we believe that customers will use more data. So as you take more data, it usually costs more. But all the basic plans will support 5G as well.

The next question is from Ondrej Cabejšek of UBS.

I wanted to clarify in terms of your -- you highlighted in your presentation that one of the impacts of the current situation is you may be booking higher bad debt provisions. Has that already happened? Or is this a potential future event? And related to that, could you give us an outlook for working capital for the rest of the year? Because I noticed your net debt actually went up quarter-over-quarter. I assume this is because of some working capital event. Could you clarify what the outlook is there?

Ondrej, I just want to make sure you were referring to the changes in working capital or changes in free cash flow. I'm not sure I was following your question quite all the way.

So my -- yes, so the first part of the question is whether -- because you're highlighting bad debt provisions as a potential negative impact from the current situation. I wanted to understand whether you've already booked some or whether this is more a potential second half of the year event? That's one question. And then the second question relates to the outlook for working capital in the second half of the year because, presumably, you had a pretty negative number in the second quarter.

So I'll start with the second question because I'm still starting to understand the first one. This -- the main changes in working capital, first of all, the Sakia -- or free cash flow, first of all, is the Sakia sale that we've had. That's a major change in free cash flow quarter versus quarter. And then as for the working capital, we've had some onetime expenses. For example, we had expenses for payments to wholesale providers which we provisioned already accounting-wise by the end of 2019, but the cash flow just came out of this quarter. That's one example, and that's a onetime expense. And also for the payments for early retirement this quarter versus the corresponding quarters were a bit higher. So those are the 2 main big changes in working capital. And I'm not -- I didn't really quite follow you on the first question.

Well, so on Slide 4, you are saying that one of the challenges that you -- the potential rise in doubtful debts and collection issues and some operators have already booked higher bad debt provisions in the second quarter. So the question really was has that happened at Bezeq in the second quarter and if not, the likelihood that, that happens in the remainder of the year or so.

So we did provision higher for doubtful debt as a precaution. But so far, as far as the actual debt collection goes, we haven't seen worsening in debt collection, and this is something that we will be looking at into the future also, possibly into 2021. But just to sum up, we really haven't seen, besides the provision -- the higher provision that we've established into the financial statements. In terms of the actual doubtful debt or any worsening in debt collection, we haven't seen a substantial worsening in debt collection.

Okay. And one maybe follow-up on the 5G question previously. Can you clarify whether the amount that you paid or are expected to pay for the spectrum was part of your -- or is part of your guidance for this year, CapEx guidance? If I'm not mistaken, it was part of the 2019 guidance.

None of it will be paid this year at all. The whole transaction with the MOC will be paid out by 2022, and there's a cut in the -- also in the -- it depends how much sites you deploy. So it's not in the current year outlook at all because it's not going to be paid this year, and the net payment will be possibly lower.

Okay. Understood. And final question, please, on 5G, do you expect that because of some of the network share agreements that your competitors have that the deployment of 5G is likely to end in more consolidation that we're seeing currently? Is that management view, basically is what I'm asking.

Well, this is Ran. I'm not sure I get the question. There are 2 shared networks. One is owned by Cellcom and Xfone, other one by Partner and Hot. So we took the auction exclusively. We're going to use the tenders for our network. So could you repeat the question, please?

So I think my question is more like, I believe that the agreement between Cellcom and Xfone is set to go on firmly as well. Is that -- they basically split the CapEx going into the network, either 2 ways or 3 ways. It used to be 3 ways. Now it's 2 ways because of the Golan acquisition. So do you think that potentially we'll see another merger in the market? Is that your view?

I cannot say. I don't know.

[Operator Instructions] There are no further questions at this time. I would like to inform participants that a replay is scheduled to begin in a period of 3 hours on the company's website at www.bezeq.co.il. Mr. Rothenberg, would you like to make your concluding statement?

Yes. I would like to thank you all for taking the time to join us today. Should you have any follow-up questions, please feel free to contact our Investor Relations department. Management looks forward to speaking to you on the third quarter 2020 earnings call. Thank you.

Thank you. This concludes Bezeq's Second Quarter 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.