Investor Releases

Solid performance driven by successful strategic initiatives

Budapest, November 4, 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 nine months of 2010, in accordance with International Financial Reporting Standards (IFRS).

Highlights:

• Revenues were down by 5.8% to HUF 452.6 bn in the first nine months of 2010 compared with the same period in 2009. This was mainly due to lower fixed and mobile retail voice revenues in all three countries, together with a decline in Hungarian data revenues. These declines were partly offset by growing Hungarian TV, mobile internet, and System integration/IT revenues. However, the appreciation in the Hungarian forint resulted in somewhat lower revenue contributions from international subsidiaries, reflecting the translation impact (the forint strengthened on average by 3.0% and 2.6%, relative to the Macedonian Denar and the Euro, respectively, in the first nine months of 2010).
• EBITDA declined by 7.6% to HUF 186.9 bn , with an EBITDA margin of 41.3%. Underlying EBITDA, which is EBITDA excluding investigation-related costs, severance payments and accruals, and related provision reversals decreased by 7.5%. Underlying EBITDA margin was 42.2% in the first nine months of 2010 compared to 43.0% in the same period of 2009. The decline in voice related payments (reflecting lower traffic volume and the cut in the Hungarian mobile termination rates) and the cost-cutting driven decline in employee related and other operating expenses were not sufficient to offset the high margin voice revenue decline.

• Profit attributable to owners of the parent company (net income) decreased by 15.6%, from HUF 67.4 bn to HUF 56.9 bn. The decline was primarily driven by lower EBITDA and higher income tax, only partly offset by lower net financial expenses. The decline in net financial expenses was due to the combined impact of the significantly lower average interest rate and the lower average net debt level. At the same time, the higher income tax expense reflects the Macedonian tax law changes that took effect from July 2010, resulting in a one-time HUF 5.2 bn deferred tax liability increase related to the requirement to book corporate income tax on profit reserves that are expected to be paid out as dividend later on to non-resident entities. This increase could not be offset by the lower tax base and the removal of the solidarity tax in Hungary from this year on.
• Net cash generated from operating activities increased from HUF 147.7 bn to HUF 148.2 bn. The lower EBITDA was more than offset by an improvement in working capital , primarily thanks to our focus on working capital management and also to the release of severance-related provisions in the first nine months of 2009. Furthermore, net financial charges also declined compared to 2009 driven by a significantly lower effective interest rate. Tax payments decreased mainly due to the removal of the solidarity tax in Hungary.
• I nvestment in tangible and intangible assets (CAPEX) decreased by HUF 17.2 bn to HUF 54.3 bn in the first nine months of 2010 compared to the same period in 2009. Of total CAPEX, HUF 13.2 bn is related to the Consumer Services Business Unit, HUF 2.3 bn to the Business Services Business Unit, HUF 2.4 bn to Group Headquarters and HUF 26.8 bn to the Technology Business Unit, whilst in Macedonia and Montenegro, CAPEX spending was HUF 7.2 bn and HUF 1.7 bn, respectively.
• Consequently, operating cash flow adjusted for investments in tangible and intangible assets as well as cash purchases significantly improved, from HUF 64.6bn in the first nine months of 2009 to HUF 89.7 bn in the first nine months of 2010. Furthermore, free cash flow, defined as operating cash flow and investing cash flow adjusted for proceeds from / payments for other financial assets, improved on a similar scale, from HUF 64.0 bn in the first nine months of 2009 to HUF 89.7 bn in the first nine months of 2010. The level of cash used for purchase of subsidiaries was comparable in both years, while the somewhat lower amount of proceeds from the disposal of PPE was more than offset by the proceeds from the sale of Orbitel.
• Net debt decreased from HUF 284.3 bn to HUF 278.4 bn by the end of September 2010 compared to the end of September 2009 level driven by the improved free cash flow performance. The net debt ratio (net debt to total capital) was 32.3% as at the end of September 2010.

Christopher Mattheisen, Chairman and CEO commented: “Our performance during the third quarter reflects the first signs of economic recovery which emerged during the period, but more importantly the success of our strategic initiatives. We are particularly pleased with the broad range of bundled products we offer in the residential segment, which now also include quadruple play packages, and the variety of integrated telecommunications-IT offerings we provide to our corporate customers. These strategic initiatives allowed us to maintain our market leadership in our key markets, whilst making significant progress towards our goal of becoming the market leader in the pay TV market.
As a further step in organizational transformation, we are introducing additional changes to the way we serve our customers. Given that most of our small- and medium-sized business customers require products from our residential portfolio and are already served to a large extent by our mass market segment, we have decided to officially transfer them to the mass market  segment effective January 1, 2011. This step will also reduce the number of accounts handled by our Business Services business units and enable us to increase our focus on key customers and projects which truly require our unique complex telecommunications and IT solutions.
Looking ahead, the special tax imposed on the telecommunications sector among others will have a considerable impact on our results. The estimated total special tax amount payable by the Company in 2010 will be around HUF 27 billion, which is expected to impact EBITDA. We are in the process of reviewing how the special tax will affect our plans beyond 2010. The Government saving measures which we previously expected to have an impact of HUF 5-7 billion on both our revenue and EBITDA lines will have a more moderate effect on this year’s results, however it will also affect the results of the following years. Consequently, we expect the declines in revenue and underlying EBITDA (excluding the impact of the special tax) in 2010 that were previously guided to be down 6-8% and 7-9% respectively, to be closer to 6% in the 6-8% range  and 7% in the 7-9% range. In terms of our CAPEX, we reiterate our intention to reduce overall CAPEX levels in 2010 by 10% compared to 2009. ¹

1 The comparable figures for 2009 are: revenues of HUF 644.0 bn, underlying EBITDA of HUF 262.8 bn and CAPEX of HUF 101.9 bn.

Q3 2010 results analysis

Group

• Revenues declined by 3.3% in Q3 2010 compared to the same quarter in 2009. Retail fixed voice revenues decreased in all markets, reflecting the still unfavorable economic environment and intense competition. At the same time, retail mobile revenues in Hungary declined driven by our business customers’ rationalization efforts whilst wholesale mobile revenues were affected by the cut in mobile termination rates introduced at the beginning of 2010. These could not be fully offset by the higher TV and mobile broadband revenues.
• EBITDA was down by 5.2%, while underlying EBITDA declined by 2.9% in the third quarter of this year. The EBITDA decline was a direct result of the lower revenues that could not be wholly offset by the cost cutting initiatives aimed at reducing marketing, material and maintenance and consultancy expenses.

Consumer Services Business Unit (CBU)

Revenues before inter-segment elimination fell by 1.3% to HUF 80.0 bn and EBITDA increased by 2.7% to HUF 49.3 bn in the third quarter of 2010 compared to the same period of 2009. EBITDA margin increased to 61.7%, as our disciplined efficiency improvements aimed at both employee related expenses and other cost items more than offset the negative revenue impact.

• Fixed line revenues declined by 5.9% to HUF 30.9 bn in Q3 2010, driven by the voice revenue decrease 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 (exceeding 640,000), internet revenues decreased slightly by 0.8%, reflecting the declining tariffs and migration towards lower priced packages. The negative impacts were partially offset by the growth in the TV customer base, resulting in a 19.0% increase in TV-related revenues. The number of total TV customers exceeded 725,000 by the end of the third quarter with growth driven by both the satellite TV and the IPTV service.
• Mobile revenues increased by 1.9% to HUF 49.1 bn in the third quarter. The higher usage and the considerable increase in the portion as well as the total number of postpaid customers successfully counterbalanced the unfavorable impact of lower effective tariff levels. Furthermore, while the 16% cut in mobile termination rates effective from January 2010 negatively impacted wholesale revenues, it was offset by higher non-voice revenues thanks to the 58.6% increase in mobile broadband subscriptions supporting the growth in mobile internet revenues. Although T-Mobile’s customer base decreased compared to the September 2009 level, this was mainly due to increased churn of inactive customers and cancellations of double and triple SIM cards. Consequently, T-Mobile increased not only its market share amongst active customers to 44.8% but also its total number of active customers by 2.2%.

Business Services Business Unit (BBU)

Revenues before inter-segment elimination were down by 4.3% to HUF 37.3 bn while EBITDA decreased by 16.6% to HUF 17.0 bn in the third quarter of 2010. The EBITDA margin declined to 45.7%, reflecting the higher percentage of the lower margin SI/IT revenues within total revenues.

• Fixed line revenues were down by 12.7% to HUF 10.4 bn reflecting the negative impact of the macroeconomic environment on business customers’ telecommunications spending. Fixed voice revenue erosion remained elevated due to the high churn among customers, coupled with significant price pressure, which was also prevalent in other product categories.
• Mobile revenues decreased by 14.1% to HUF 14.9 bn driven primarily by the price allowance given to the Government which resulted in lower other mobile revenues. At the same time, the significant decline in the average tariff level that could not be compensated by higher levels of usage and the slight increase in our customer base. Furthermore, mobile revenues were also negatively affected by the cut in mobile termination rates effective from January 2010.
• SI/IT revenues were up by 23.2% to HUF 12.0 bn in the third quarter of 2010, partly supported by the contribution of ISH, consolidated since December 2009. Whilst overall investment levels remain lower than normal due to the current economic environment, some IT investments in the private sector could not be postponed any longer, contributing to the increase in our SI/IT revenues.

Macedonia

In Macedonia, revenues decreased by 1.1% to HUF 20.8 bn in the third quarter of 2010 compared to the same period in 2009, with EBITDA increasing by 3.7%. Excluding the FX impact (the Hungarian forint weakened on average by 4.8% compared to the Macedonian Denar in the third quarter), revenues were down by 5.6% and EBITDA declined by 1.0%. Consequently, the EBITDA margin improved from 54.5% to 57.1% in the third quarter compared to the corresponding period of last year, reflecting the cost saving measures in marketing, the improved payment collection efficiency and the increased provisions in third quarter of 2009.

• Fixed line revenues slightly declined by 1.7% in local currency terms. Although intense competition from alternative, cable and mobile operators resulted in a further decline in outgoing traffic volumes and a high annual churn rate, these trends were almost fully offset by higher wholesale voice revenues, driven by growing incoming and transited traffic volumes and higher settlement prices charged for international traffic termination and transition. This positive impact was coupled with increasing demand for double and triple play packages, resulting in higher internet and TV revenues.
• Mobile revenues declined by 8.4% in local currency terms driven by intensifying competition. Although the customer mix improved and the number of postpaid subscribers increased, the significant reduction in the prepaid subscriber base and the competition-driven tariff reductions put pressure on revenue levels. The postpaid ratio was up to 32.2% by end-September 2010 compared to 29.3% in the same period last year, which, coupled with more widely used closed-user-group offers, resulted in higher MOU. Despite the increase in mobile internet usage and the higher number of SMS messages, non-voice revenues declined compared to the third quarter in 2009 due to promotions containing free and discounted SMS messages.

Montenegro

Revenues of the Montenegrin subsidiary increased slightly by 0.3% to HUF 9.6 bn in the third quarter of 2010 compared to the same period in 2009, with EBITDA declining by 14.1%. Excluding the impact of the HUF 1.0 bn provision reversal (created in Q1 2007) related to litigation in connection with a voluntary redundancy program in Q3 2009, EBITDA improved by 8.5% in the third quarter of 2010 compared to the same period last year. However, excluding the FX impact (the Hungarian forint weakened on average by 5.4% against the Euro in the third quarter of 2010 compared to the same quarter in 2009), revenues declined by 4.9%, while underlying EBITDA was up by 3.0%. The increase in underlying EBITDA was primarily driven by the ambitious cost efficiency measures that were implemented, particularly with respect to marketing and consultancy expenses and technological support costs. The underlying EBITDA margin improved from 39.9% to 43.2%.

• Fixed line revenues declined by 3.1% in local currency terms in the third quarter of 2010 as increasing internet and TV revenues could only partly offset the lower retail and wholesale voice revenues. The decrease in retail voice revenues was due to increased mobile substitution driven by decreasing mobile tariffs which had a negative impact on fixed voice usage. The 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.
• Mobile revenues were down by 6.6% in local currency terms. The voice revenue decline was primarily driven by the lower number of subscribers and a reduction in visitor revenues, which was the combined result of lower price levels and stable traffic volumes. The decline in non-voice revenues reflects the lower customer base as well as the lower SMS prices.

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 24.6% to HUF 2.1 bn while the EBITDA loss narrowed by 6.3% to HUF -9.9 bn. CAPEX amounted to HUF 9.8 bn in the third quarter of 2010.

Group Headquarters

Revenues before inter-segment elimination were down by 12.5% to HUF 30.0 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 -5.2 bn, as the decline in revenues and increased employee-related expenses driven by last year’s HUF 1.2bn severance provision reversal could only be partly offset by the lower level of voice-related payments and other operating expenses.

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.
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 and the first and second quarter of 2010 furnished under cover of Form 6-K and the Company’s annual report 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 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. 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. In addition, the Montenegrin Supreme State Prosecutor is now also investigating the activities of the Company’s Montenegrin subsidiary that were the subject of the internal investigation and has requested information from the Company’s Montenegrin subsidiary in relation to the relevant contracts. These governmental investigations are continuing, and the Company continues to cooperate with those investigations.
The Company, through its external legal counsel, has recently 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 September 30, 2010 with respect to the investigations.
Magyar Telekom incurred HUF 2.0 bn expenses relating to the investigations in the first three quarters of 2010, which are included in other operating expenses of Group Headquarters.

Internal review relating to T-Mobile Macedonia
During the second quarter of 2010, Magyar Telekom became aware of misstatements at T-Mobile Macedonia relating to the recognition of certain deferred (prepaid) revenues and initiated an internal review. The Company has informed its Audit Committee, its independent external auditor, the DOJ and the SEC of the misstatements and that it was conducting an internal review.
Based on the final results of the internal review, the Company concluded that deferred prepaid revenues for the first and second quarters of 2010 and the years ended December 31, 2006, 2007, 2008 and 2009 were misstated. The final results of the internal review do not indicate that any amounts in periods before 2006 were misstated.
As previously announced, the Company extended its internal review to other accounts in relation to T-Mobile Macedonia. The Company has concluded this review and has not identified any material misstatements that would affect the interim and year-end financial statements of Magyar Telekom for the current or prior periods.
In light of the amount of the misstatements and the lack of any indication that senior Magyar Telekom executives directed or knew of the misstatements, the Company has reached the conclusion that the misstatements were immaterial to the Company’s previously reported consolidated financial statements and are immaterial to the Company’s current consolidated financial statements and to its prior assessment that internal controls over financial reporting were effective. The Company adjusted the remaining balance sheet misstatement in the second quarter of 2010. In addition, the Company has initiated remedial actions to mitigate the risk of similar misstatement in the future, including actions related to personnel and steps to further improve the control environment.

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.