Conference Call Transcript 4Q07/2007 Results February 1 st, 2008

Transcription

1 Operator: Good afternoon ladies and gentlemen. At this time we would like to welcome everyone to NET Serviços conference call to discuss its 4Q and 2007 Results. The audio for this conference is being broadcast simultaneously through the Internet at the website: We would like to inform that all participants will only be able to listen to the conference during the Company s presentation. After the Company s remarks are over, there will be a question and answer session. At that time further instructions will be given. Should any participant need assistance during this conference, please press *0 for an operator. Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of Forward-looking statements are based on the beliefs and assumptions of our management, and on information currently available to the Company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of NET Serviços and could cause results to differ materially from those expressed in such forward-looking statements Now, I will turn the conference over to Mr. João Elek, CFO and Investor Relations Officer. Mr. Elek, you may begin your conference. Good morning ladies and gentlemen. At this time, I would like to welcome everyone to this conference. Today with us we have some members of our management team and the new CEO of NET, José Antonio Felix, to whom I will turn the conference for some brief comments on his plans for the Company. José Antonio Felix: Good morning everyone. It is a great pleasure for me to take part in this conference call regarding NET s results as the new CEO of the Company. I will take this opportunity to introduce myself and give you an idea of the steps I believe NET should take under my leadership. I would like to say that I have known this Company and the Industry for a long time. In reality, since In last five years I acted as Operating Officer implementing with the other members of the board the current growth strategy, and carrying out the necessary operating changes that led to the present results. As CEO, I will pursue those goals NET has been pursuing along these years with greater intensity, sustainable growth, positioning NET as market leader in the Pay TV segment, 1

2 accelerating the voice business growth and continue benefiting from the increasing opportunities in the broadband market. I am sure that the triple play strategy makes every sense, and this is why it will be one of my main goals as CEO: to sell, serve, install and position NET as a multi-service Company, ready to meet the telecommunications and entertainment demand from our clients homes. Quality is another key point to be considered. Although we have made important achievements in this area, I believe one of my most important challenges is to turn NET into a customer service benchmark. In this competitive scenario, we have to face the increasing challenge of maintaining our strong performance. However, I believe that 2008 will be a very positive year for NET, as we continue our expansion within this industry, giving priority to capital discipline and creating value for our shareholders. I am counting on your support to meet the challenges along with NET. Now, I will hand the conference back to João, who will comment on our results. Thank you. Thank you, Felix. As I have always done, I will start commenting on the main highlights for the quarter and the year, and then open the Q&A session. I would like to remind you that the results for this quarter and for the year include VIVAX s result, which became a wholly-owned subsidiary of NET. And, for a better analysis of our performance, we will base our comparison on the pro-forma results of NET and VIVAX for the quarter and the year ended December It is important to observe that, in the 4Q, CADE authorized the acquisition of VIVAX, ratifying the good faith in which the Company has always acted. For the benefit of those that do not know, CADE is the anti-trust agency in Brazil. Beginning with the operating performance, we continue to grow at attractive rates that are above the market average, for all our products. This happens in a highly competitive market, in which NET continues to implement its accelerated growth strategy through the offering of differentiated product quality. In the last quarter of the year, the Pay TV subscriber base grew by approximately new subscribers, the broadband subscriber base expanded by , and the voice subscriber base grew by almost In the year, net additions in the three products totaled , and respectively. As for disconnection rates, VIVAX s operations churn rate was slightly higher compared to NET s. Thus, after we consolidated the base, Pay TV and broadband churn rates recorded a small increase. In addition, there was an increase in the number of involuntary 2

3 disconnections, due to a disconnection action carried out in the 4Q07, possibly associated with a higher percentage of the codified network. Pay TV and broadband churn rates stood at 15.4% and 17.1% respectively. Despite this increase, our disconnection rate remains quite low, and we are confident that it may return to the levels recorded prior to the acquisition of VIVAX. In November, with the conclusion of the subscriber management systems integration, we began the NET products offering campaign in the cities previously served by the VIVAX brand and products. We eyed not only a retention opportunity, but also an opportunity to raise the ARPU by offering not only a more complete programming, but also higher speed broadband services and an option for the voice service. As we had commented previously, as we were able to capture synergies with VIVAX, we would share them with the market. Until this moment, we achieved annual savings of 8% in VIVAX's programming cost, and 28% savings in IT-related costs. We also had a payroll reduction of around 10% in the operating area and 13% in the administrative area, due to the elimination of positions overlapping. Altogether, these lines represent annual savings of R$13 million in the operating costs and expenses. As for CAPEX, our scale allowed for a reduction of up to 55% in the purchase of certain equipments. In December, we presented to the market our new product NET Digital HD, which offers clients not only the whole digital programming jointly with the newly launched highdefinition programming, but also the programming recording service in a single box. Also in the end of 2007, we announced the purchase and sale agreement for the acquisition of BIGTV operations. This is another important acquisition for NET s strategy, since it covers important cities like Guarulhos, Marília, João Pessoa and Maceió, in addition to 12 complementary operations. The transaction is subject to ANATEL s approval, which we expect to obtain in the 1H08. In 2007, net revenue moved up by 28%, totaling R$2.901 billion against R$2.267 billion in ARPU, which is the average revenue per user, climbed 9% in the year, from R$121 to R$131 in This result can be mainly explained by the growth in the subscriber base and the Company's ability to sell clients not only more products, but also products with higher aggregated value. Operating costs totaled R$1.38 billion in 2007, a 30.7% growth compared to R$1.056 billion in the previous year. The programming cost moved up by 20% in the year, mainly due to the increase in the Pay TV subscriber base, while the other operating costs, which mainly include the call center and the Internet link, moved up by 75% in As for the Call Center, this increase was due to the change in the customer service model and its consequent redimensioning, aiming at serving not only a larger client base, but also covering a greater diversity of subjects arising from product and service diversification. The increase in link expenses results from the higher number of broadband clients, in addition to the growth in the number of high-speed connections. 3

4 Selling, general and administrative expenses, SG&A, totaled R$736 million in 2007, a 35.9% growth compared to R$541 million in Selling expenses went up by 23%, resulting from higher sales commissions expenses, due to the increase in the year s sales volume, besides an increase in advertising campaign expenses. General and administrative expenses rose by 17%, mainly due to higher expenses with consulting services associated with VIVAX s integration. The other general and administrative expenses grew compared to the previous year, mainly due to the non-recurring equalization of the accounting estimates for fiscal and labor contingencies carried out in VIVAX, as well as several reversions of contingencies during Consolidated EBITDA totaled R$804 million in the year, a 26% growth versus R$639 million in EBITDA margin stood at 28%, within the level considered to be adequate by the Company, considering the implementation of a strong organic growth strategy in a fierce competition scenario. The financial leverage level remains low. Net debt at yearend totaled R$555 million, a 4.7% growth compared to R$530 million in The net debt/ebitda ratio for the last 12 months dropped from 0.83x to 0.69x. In addition, the Company has no significant principal amortization in the short term. Without considering FINAME amortizations, which do not materially affect our cash position in the first years, the Company only begins to amortize debt principal by the end of In the year, our cash disbursement with investments had totaled R$770 million. Of this total, R$235 million were used in specific bidirectionalization and digitalization projects, and R$535 million were aimed at the Company's current investments. The Management considers the possibility of raising debt up to US$200 million, under acceptable cost and term conditions, whose funds would be mainly used to finance the acquisition of BIGTV, and the remaining balance would be used to fuel our growth. Our shares keep presenting strong liquidity. In the year, trading volume on the Bovespa totaled US$56 million of everyday transaction, a 56% growth compared to 2006, as well as on Nasdaq, where the average daily traded volume rose 532% in 2007, from US$1 million to US$7 million. As we have been widely commenting, we do not foresee market changes that could significantly affect our accelerated growth strategy in Competition is already strong, with competitors positioning themselves to match our offerings. However, we still believe we are well positioned in the market, with a complete Pay TV offering and broadband speed differentials, as well as an attractive voice offering. All this added to the fact that we are the only company that offers truly converging services, thanks to our cutting-edge infrastructure that combines fiber with coaxial cables. We are more than ever seeking to serve our subscribers with increasingly better services. We will put more emphasis on quality, allowing NET to increasingly win clients trust, and be truly seen as a company that not only respects the clients rights, but also provides services that really enchant them. 4

5 Accordingly, NET s EBITDA margin should remain at the current 26% and 28% levels. Growth and subscriber acquisition CAPEX should remain close to R$550 million. In addition to growth CAPEX, the Company should also invest in the digitalization of its clients and network enhancement projects, ultimately aimed at improving customer service quality. NET should invest approximately R$200 million in these two projects, resulting in a total CAPEX of approximately R$750 million in Under this margin and CAPEX viewpoint, although we currently believe this should be the most likely scenario for 2008, I would only like to remind you that growth margin and CAPEX are directly related to our net additions pace. In other words, should the market bring even bigger growth opportunities compared to the current ones, the margin may remain slightly below the forecasted level, and growth CAPEX may be slightly above, the contrary being valid in case of smaller growth. Again we received strong support from everyone who follows up on the Company s results. Despite the volatile market and some uncertainties, we have been holding meetings and interesting discussions about NET, always with good suggestions on how to benefit from NET s differentials. I would like to thank everyone who helped building another year of success and achievements. We may now begin the Q&A session. Miguel Garcia, Deutsche Bank: Thank you. I wanted to understand a little bit the CAPEX increase in this 4Q, and what should be the level in 2008, I understand that the CAPEX is increasing as you have a more aggressive digitalization plan; so besides the CAPEX guidance, I would like to know what is your plan to turn into a percentage of digital subscribers for you in 2008 and And also if you could give more color on the disconnection of subscribers in the 4Q, if it was triggered by no payment, you mentioned in the press release that it was mostly driven by the Company, not by the voluntary churn. Those are my two questions. Well, CAPEX, we did not anticipate any initiative of 2008 in Actually, we concluded the digitalization and bi-directing the network as we planned, and given the highly regarded reactions of customers when we replaced the analog set up box by a digital one and this gave us a big opportunity to increase revenues, we accelerated this process a little bit in the 4Q, but other than that it was pretty much what was in our expectations. And for 2008, about CAPEX, as I mentioned, tends to be around R$750 million. I cannot anticipate how much it is going to be by quarter, I believe that the variable CAPEX will be very much back to the seasonal sales profits, so we sell more in the 3Q than in any other quarter of the year. Usually the 1Q is our low tide when schools are on recession; people are usually on vacations and so on. Percentage of digitalization, at this very moment, I can say the following: that is about 40% of our customers have digital services, and we will continue growing this percentage. We 5

6 do not have a specific figure for this year or for the next year, but what I can say is that this is a trend that will remain for the long term, more and more customers will have digital services. At this point, 80% of our network is already digitalized. And the churn that we had in the 4Q yes, I can say that we had this involuntary trend and this includes not only let us say delinquent subscribers but also some subscribers that decodefied the network, we were able to catch some subscribers that had access to programming for which they were not paying. So, some of them were delinquent, some of them were not really swap with their package, and this way we decided to disconnect them. But this involuntary disconnection in this particular quarter represented about 60% of total churn and the other 40% was pretty much flat to our usual levels. Andrew Campbell, Credit Suisse: My question is on competition. You had a full quarter with Telefonica competing with your DTH product in São Paulo, and I was wondering whether or not you have seen any change in the market conditions at all, if there has been an increase in competition and in terms of also with Sky, whether or not they are being more aggressive and if this is having any impact you think on the market. Actually, competition in this 4Q we did not notice changes when we compare to the previous quarter. The DTH offer of Telefonica is a good one, the market is large but we did not notice any slow down on demand, our gross sales were very strong in the 4Q, obviously influenced by the number of business days, November had a lot of holidays and December is the year-end season. But anyway, we did not notice any slow down in sales. We believe that despite the fact of, let us say, this more intense competition our offer continues to be very attractive and have a strong appeal in respect to DTH cable whichever is the competition that we face. And Sky I would say that this is also applicable for Sky to the same extend. Andrew Campbell: OK, I understand. If I could ask a follow-up on CAPEX, just to clarify. Did you say that of the 2008 CAPEX of R$750 million there was R$200 million that was non-recurring or related to bi-directional digitalization? No, for 2008 you are right about the R$200 million of these discretionary targets, we will continue digitalizing the network and we will make some other upgrades but not the bidirecting efforts; these have been concluded in The other enhancements are things such as energy large concentration, we can deploy more cable to make it redundant and things like that. 6

7 Andrew Campbell: OK. And is there any BIGTV CAPEX embedded in the R$750 million? No, it does not. This is, let us say, organic CAPEX for the existing operation NET + VIVAX; it does not include any projection with BIGTV. Actually, I do not even know when there is going to be approved, so I do not want to anticipate. If we have the approval early in the year, we will have more time to make the investments; if it is approved in December, then the year is over. Andrew Campbell: Understood. OK, thank you. Guilherme Assis, MS: I would like to pose a question on the ARPUs of the Company and the migration to digital video client. I would like to understand what kind of additional services you offer and how higher your ARPU is for these clients in relation to your regular client base. Well, Guilherme. You know, in 2005 the Company decided not to disclose detailed levels of the breakdown of the ARPU. We consider NET as a multi-service company and giving you, let us say, this level of breakdown of components of ARPU for digital services is like asking Coca-Cola its formula. So, I can say the following: usually that is a very common question, new subscribers usually buy lower services and overtime they migrate to more premium types of services; customers that have broadband get used to the service and they migrate to higher speed broadband and so on. This altogether has been the propelling factor behind the increase of ARPU. And someone who migrates from analog Pay TV line up to a digital one follows the same trend. So if you go for our price list on our offering, you can buy programming, let us say an advanced package, for a certain price and if you compare a similar package of the same level which is digital, according to our price list, this can be up to 30% more expensive but you will have not only more services but a larger line up of channels. Guilherme Assis: OK, thank you. 7

8 Peter Lyons, Oscar Gruss: Hi, João. Actually I have two questions. The first question is regarding the sales deductions and it was noted in the earnings release that the rate is slightly higher due to higher taxes paid on the sale of broadband services. The first question is: can we expect the higher rate looking forward? In the 4Q it represented 22.7% gross revenues versus 22.4% in the 4Q. So, can we expect that going forward? Question number two is regarding the high-definition packages that you offer. How much do you charge for these types of services; how many channels; and how many HD subscribers do you have? Thank you. With regards to your first question, the answer is: yes. Let me give you a little color on that. Pay TV services carry a certain percentage of tax rates, and, let us say, an EVA tax. Broadband has a larger EVA tax percentage. So, to the extent that we have more and more broadband subscribers, the blended tax rate or tax deduction over the gross sales tends to increase. So, I believe that you are asking me if this will be a trend: it is correct, it will continue to be a bit heavier tax-wise, as long as we have more broadband subscribers. In terms of the high-definition offer, actually, the high-definition programming in Brazil began in December and these are the free to be aired channels which are now according to HD protocol. For these we are offering or transmitting this programming, but right now we do not have a package that is only high-definition, and for that we have a separate cost. Right now what we are offering is a set-up box, which at the same time offers recording capabilities but it is also converting the signal of high-definition to one that the TV set can read, because the protocol or the standard of HD is a Japanese one which has to be converted. So, what we are doing in this regard is providing a box which at the same time converts the signal, allows you to have access to digital services and record the programming. Let us say, the HD base of subscribers at this time is very insignificant. We launched this box in mid-december and we started to sell in January. So, the numbers at this moment are immaterial. What I can say is that those who have it are very satisfied and we have more and more calls asking for these boxes. Peter Lyons: OK, thank you. Donald McLachlan, UBS Wealth Management: Good morning. I have a question related to the risk factors that are mentioned in the prospectus of your perpetual bonds. It is related to the legislation approved in the City of 8

9 São Paulo about moving the cable networks from the ground facilities. Any update on that? What is the likelihood of it being enacted, and what is the potential effect on the Company? That is a very interesting question. I have no update other than the fact that this enactment, in practical terms, is totally undoable. It is not a major concern of NET, but if you talk about electric companies, they have their entire infrastructure over poles. And how come that now we are going to destroy the entire city at the same time, dig the city to put it underground? So, we do not consider this as something which is feasible. No major developments in this regard, and all infrastructure companies are standing still because there is nothing to be done. It is impossible to change or move from aerial networks to underground networks, let us say, the entire infrastructure of a huge cities like São Paulo, or Rio. These cities are really huge, we are not talking about something to be done, let us say, in a quarter, we are talking about centuries. So, no news on this front. Donald McLachlan: OK, thank you. Fernando Ramos, GBM: Good morning. My question is: as your Pay TV subscriber base continues to grow, I was wondering if you anticipate any economies of scale regarding programming costs. Do you expect this to grow as fast as (inaudible) and your Pay TV subscriber base? That is a good point. Let me say the following: to the extent that I have a larger subscriber base on Pay TV, I am able to reach a scale benefit, but let me explain you how. Whenever you reach a certain (inaudible), you get a discount for the additional incremental subscribers. For instance, you get a 5% discount this is not applicable to the existing base. This is will be on for the new additions. So, over time, let us say, if I grow my base 2x or 3x, I can that I will have a significant scale gain in comparison to where I am now, but I have to double, to triple my base, because this is only for the incremental, not for the existing base. On the other hand, we have more and more customers asking for more premium packages, which means that they are buying packages with more content and more programming cost. So, our mix of programming cost per subscriber is moving up on one hand because we have customers with more sophisticated packages, but on the other hand, the larger our subscriber base is, the cheaper the new customers get. 9

10 Fernando Ramos: OK, thank you. Alex Garcia, Raymond James: My question is a follow-up on this programming cost issue. Basically I was wondering: BIGTV has 40% EBITDA margin. VIVAX has 40% EBITDA margin, but when you combine with VIVAX, your consolidated EBITDA margin drops to 26% or 27% level. In my opinion, this is basically due to Globosat s premium channels, is not it? This is absolutely right. Alex Garcia: That is the issue. I mean, we have seen other Pay TV players around, especially in Latin America, which have better EBITDA margins. I was wondering: does it pay off? Because it seems expensive. We have Cable Vision, now that we have access to their numbers; their revenue per RGU is around US$220, and NET reported at the end of this year US$350. Their margin is 34%, and your margin is 26%. So, my question is: we are talking about a 10 p.p. in the EBITDA margin for Globosat s premium channels. Is it not too expensive, as a programming cost? When should we see an add above 30% of the EBITDA margins? We can add, at least, more elements to your analysis. The cable content is really expensive; if I give you a base of comparison, a term of reference, VIVAX had a programming cost equivalent to 18% to 19% of net revenues before we incorporated operations. NET has about 27% to 28% of its net revenues, so this gives you, really a 10% difference. There are other components, a little bit more about that. When talking about any United States company, we have a different scale. So, United State companies, English language content, this is something which is understood across the board, everywhere you go, you have this content. So, you can buy it and dilute its cost. Portuguese content and when we talk about Portuguese, is Portuguese spoken in Brazil, which is very much different from the accent of many other places we do not have the scale to dilute the cost, so I do not think that this global content will ever be comparable when we analyze this cost per subscriber. It will always be a more expensive content. But there are other components in the balance sheet, for instance, BIGTV and VIVAX, they were growing at a much lower pace than NET is growing, so our plan is to have an accelerated growth strategy, and we will accelerate the growth in both networks. In other words, this can mean that there are 4% to 5% of EBITDA margin, but we believe that that 10

11 is the way to increase the customer base, bring more, in absolute terms, return to customers and increase value for shareholders. Alex Garcia: If you allow me a follow up on this, could you give us some color if there is going to be any drop on the participation of programming cost as a percentage of net revenues in 2008? In the consolidated figures for 2007, it was R$25.6. Do you have any idea, or any guidance what should it lend? 3% down? I do not have a guidance on that, but you are right. We started the year with, let us say, a programming cost equivalent to 28% of revenues, and we ended the year with 25%. And this is because we are diversifying the sources of revenues, we have more broadband, and we have more voice revenues. And, altogether, they are helping dilute the programming as a percentage of total revenues, and this will continue to decline, and that is our expectation, because both voice and broadband customer base and revenue base, as a consequence, grow faster than the Pay TV, which is a more consolidated line of cost. Alex Garcia: OK. Than you. Peter Lyons, Oscar Gruss: Hi. My follow up is regarding the other operating costs; you have mentioned the increase and the bandwidth cost, I guess at a level of about 12% of net revenues, currently. I was wondering: Can we expect this elevated cost going forward? As broadband continues to grow, or do you see it normalizing back to, I guess, some of the levels from an earlier year, that is question number one. And then, question number two, if you could just go through the savings from the VIVAX acquisition again; you have mentioned a total of R$20 million, if you could just give the breakdown of that. Thank you. I think that, with regard to the cost of the link, direction, I think you are right. The most likely trend is that it will continue to grow a little bit, and this is because we have in our broadband subscribers, their demand for speed is moving upwards. So, you have many people downloading movies, listening to sounds, transmitting large files, so this is both download and upload. So, I think that this is a trend that will continue. This is an expensive line item that we expect to be, as a percentage of revenues, at a minimum they will remain flat, but it is most likely it is going to increase a little bit. 11

12 Peter Lyons: Who do you pay for these links? Is it Embratel? If you could just give some color on that. We have several providers; Embratel is one of them, whoever has capacity, quality and the connection, the access point, is nearby our network. But we have also Global Crossing, which is also an important provider of our links. Intelig, which is a Brazilian company; actually, it was just sold two weeks ago. And, to a smaller extent, we also buy from Telefonica. Peter Lyons: Are there any smaller players that would make sense to possibly acquire in the future? Like Intelig or anyone equivalent to that? You mean for Net to buy such company or links from those companies? Peter Lyons: In the future, could it make sense, I do not even know if with the consolidation, if there is any smaller player left out there. But I have seen you negotiate the terms of the bandwidth, it would make more sense to just acquire one of the smaller players if there is one that becomes available? Well, I do not have a precise answer for that. Intelig has just been sold for an SPA agreement signed by a media company A media company has made an offer for Intelig. I do not know; should we talk about, for instance, Intelig, Intelig has other business, not only the, let us say, the circuits to the Internet. They have other infrastructure items, we would have to go over the financials to answer if it makes sense or not. And when we talk about smaller players, we have concerns regarding quality. And it is not our core business to make enhancements in this type of infrastructure. I think that this business of (inaudible), this part of the infrastructure has been very successful, very much adequate, and we have the freedom and flexibility to look after whoever offers the best prices and the most convenient distribution for our network. I do not envision for instant acquisitions in this regard. Peter Lyons: And if you could just give the breakdown for the savings from VIVAX. 12

13 As I mentioned, the annualized figure of R$30 million; about R$9 million is related to programming costs, about R$10 million from payroll; IT, helpdesk and support services, about R$3 million and I beg your pardon, in terms of payroll, we can add a little bit more. I mentioned only for the operational level. All the administrative areas as well, together, they are close to R$18 million. And this is pretty much the breakdown of the R$30 million. I would also mention that a cheaper CAPEX is related to cable modems, optical fiber and cables, and those are the two major components of CAPEX. Peter Lyons: You mentioned there was a 30% saving on some of these items? We mentioned, on average, 35%. Peter Lyons: OK. Thank you. Operator: Thank you. There appears to be no further questions at this time. I would now like to turn the floor back to Mr. Elek, for his final considerations. I appreciate very much the questions, your participation. It has been tremendously helpful and important for us, the support we receive from you guys. Whenever we meet, you or your customers, we have the opportunity to learn and understand your perception of all business. The feedbacks we collect are very important to improve our business, so I thank you very much. I wish you all a very successful year, and I hope to count on you moving forward. We are very enthusiastic about 2008, and we believe we will have quarters of lots of excitement. I will just ask Felix to say good-bye and thank you all. José Antonio Felix: Thank you very much. I am very well impressed with the quality and the level of the conference. Thank you. Again, we are counting on your support. I personally think that we will have, again, in 2008, a very good year. Thank you very much. 13

14 Operator: Thank you. This thus concludes today s NET Serviços 4Q07 results conference call. You may disconnect your lines at this time and have a wonderful day. 14