Telefonica SA

Good morning and welcome to Telefónica's conference call to discuss January-June 2020 results. I'm Pablo Ridón, head of Investor Relations. Before proceeding, let me mention that financial information containing this document related to the second quarter 2020 has been prepared under international financial reporting standards, as adopted by the European Union, and that this financial information is un-audited. This conference call webcast, including the Q&A session, may contain forward-looking statements and information relating to the Telefónica Group. These statements may include financial or operating forecasts and estimates or statements regarding plans, objectives and expectations regarding different matters. All forward-looking statements involve risks and uncertainties, including risks relating to the effect of the COVID-19 pandemic, that would cause the final developments and results to materially differ from those expressed or implied by such statements. We encourage you to review our publicly available disclosure documents filled with the relevant securities market regulators. If you don't have a copy of the relevant press release and the slides, please contact the Telefónica's Investor Relations team in Madrid or in London. Now, let me turn the call over to our Chairman and Chief Executive Officer, Mr. José María Álvarez Payete.

Thank you, Pablo. Good morning and welcome to Telefónica's second quarter results conference call. Today with me are Ángel Vila, Chief Operating Officer, and Laura Basolo, Chief Finance and Control Officer. As usual, we will first walk you through the slides and we'll then be happy to take any questions you may have. We face extremely challenging operating conditions and unprecedented economic uncertainty. Still, we remain committed to our local markets and their long-term potential. An accelerated execution of our new Telefónica plan, we stayed true to our ideals, keeping in mind the long-term vision without compromising neither our strategy nor our profitability. And we did so through different means. Strengthening the value proposition in our core markets that proved the resilience within such turbulent times, with organic OEBDA minus capital growing 2% year on year in the second quarter. Staying close to our customers also pay off with record NPS levels. Making our core business more sustainable in the UK through the deal agreed with Liberty Global, as we are trying to pursue in Brazil again with the strongest possible partners, or in Spain with good commercial traction and historical levels of profitability. Sustainability and long-term profitability lie as well behind the steps we are taking in Houston, where we progress in all strategic options, including inorganic alternatives, as proven with the sale of Costa Rica only three months after Millicom refused to complete their deal. We on top optimize its business model, OEBDA minus CapEx improves 10% expoin in organic terms in the second quarter, and neutralizes FX impact via increasing debt at the local level. Securing key partners that join as well our fastest growing proposition Telefónica Tech, that grows double digit in the quarter despite COVID-19 impacts, and has generated 756 million euros in revenues in the first half. We also continue crystallizing value and monetizing assets at Telefónica Infra, as proven by the 1.5 billion euro tower transaction in Germany that doubles Telstra's scale to 33,000 towers. And as I said before, we can take all this action thanks to a new operating model based on digitalization, agility and efficiency. We paved the way for the future while proving cash preserving despite extremely challenging conditions, OEBDA minus CapEx margin improved by 1% expoin in the second quarter, demonstrating the strong execution. Moving to the next two slides, we present the swift and effective actions we have taken in response to COVID-19. In these unprecedented times, managing commercial relationship becomes all the more critical, while introducing a wide range of measures to mitigate top line impacts. We have been able to improve business efficiency and generate savings in OPEX and CapEx without compromising our business model. This has first allowed to deliver strong results at the operating cash flow level. The good news is that our customers stayed with us, allowing for a notable commercial and operational recovery since June, suggesting Q2 will likely be the worst quarter in terms of COVID-19 impacts. How can you turn more efficient in the midst of the pandemics? Fostering significant growth in sales through digital channels while relying in our secure and top quality networks. This again strengthened our customers' loyalty, which improved both year on year and quarter on quarter, with NPS reaching 24% in our core four markets. OPEX was tightly controlled, declining .9% in the second quarter year on year in organic terms, while CapEx flexibility and execution slowdown as a result of COVID-19 resulted in a .3% annual organic decline. All in all, we have neutralized a negative shock of revenues of 1.8 billion, reducing the gap gradually from top line to bottom, and we have generated a very attractive free cash flow, while improved debt reduction versus previous year. On the next slide, we show the support we have provided to all stakeholders during the crisis, with actions taken in each and every market. For our customers, we provided additional entertainment and mobile data at no extra cost. For our people, we focused on protecting the safety of all employees, with 95% working remotely, and appropriate safety measures enacted for key workers. For our suppliers, we acknowledged their need for liquidity and offered flexible payment options. For the wider society, we created a 25 million euro fund to provide medical equipment and monetary aid, made our technologically advanced buildings available for governmental and public use across the majority of our footprint, and undertook many other measures across our markets. To safeguard the environment, we updated our target of zero net emissions in our four core markets, bringing this forward to 2030 instead of 2050. And for shareholders, we maintain our dividend and offer a voluntary script for the 2020 calendar payments. Finally, we are leveraging our -the-art infrastructure to support much needed economic recovery across our markets. Moving to slide 5 to review our second quarter performance highlights. As you can see on the left hand side of the slide, revenues declined in the second quarter in organic terms, but excluding the COVID-19 impact, -on-year revenue growth accelerated. We continue to support this growth leveraging our high quality access base, ultra broadband network, and growing our digital revenues, which topped 1.7 billion euros in the second quarter. As mentioned before, effective operational management during the crisis led us to increase -minus-capEx in our four core markets by .9% -on-year in organic terms. While the margin expanded by 1.3 percentage point, a remarkable achievement given the circumstances. To note, our core markets represents more than 90% of telephonic-aggrouped -minus-capEx, which amounted to 2.1 billion euros in the second quarter of this year. And importantly, we remain on a clear deleveraging path with 1 billion euro reduction in net debt in the quarter, leading to a 7.5 reduction in the last 12 months. Moving now to guidance and dividend. Let me start with the 2020 dividend, which is confirmed at 40 euro cents, thanks to the high resilience of the business and our solid liquidity position. The dividend will be payable in two 20 euro cents tranches, the first in December 2020 through a voluntary script dividend and the second tranche in June 2021. I would like to note that for the payment made last June, 63% of shareholders opted to receive new shares, further enhancing our financial flexibility as just 371 million euros were paid in cash. Regarding our 2020 outlook, we rated the target of a slightly negative to flat -minus-capEx growth year on year, based on the signs of recovery observed in June and July and the proactive measures taken to reduce operational and capital expenditure. For reference, the first half of the year figure was down 2.3%. I'm also pleased to reiterate our targets for 2022 of year on year organic revenue growth and -minus-capEx over revenues expansion of 2% point versus 2019, based on the sustained demand and long term growth trends for connectivity and digital services. I will now hand over to Angel to take you with more detail through the group results.

Thank you, José María. Moving to slide seven and looking at our financial performance, the reported figures this quarter are significantly affected by two factors, currency depreciation and COVID-19. You can see these impacts at the bottom of the slide, and we will explain this in more detail later on. To a lesser extent, OED was impacted by the absence of capital gains booked in second quarter 2019. Revenues amounted to 10.3 billion euros, declining .8% year on year on a reported basis and .6% in organic terms. In our four core markets, revenues declined by .8% from the previous year. It is worth highlighting the continued transformation of our top line, especially in the context of the COVID-19 crisis, with 67% of our service revenues coming from broadband and connectivity services, 4 percentage points higher than one year ago. OED reached 3.3 billion euros, down .3% year on year or 10% organically. This drop was significantly lower in our four core markets, with a 6.6 annual decline in organic terms. Thanks to our focus on profitability, OED minus capex was practically flat, declining by only .7% in organic terms, and growing by .9% year on year in our four core markets, despite the challenging conditions. OED minus capex margin also increased year on year for both the group and our core markets, both in the second quarter and in the first half, thanks to the effective operational management mentioned previously. Net income reached 425 million euros in Q2 and above 0.8 billion euros in the first half. Earnings per share stood at 0.23 euros in underlying terms in the first half of the year. Free cash flow performance improved sequentially in Q2, nearing 1 billion euros. And finally, net financial debt stood at 37.2 billion euros as of June, declining .5% year on year, thanks to a 1 billion euro reduction in Q2. Slide 8 shows the financial and operational impacts in the first full quarter affected by COVID-19, with clear signs of recovery evident from June 2020. The estimated revenue impact in Q2 amounted to nearly 730 million euros, with a 338 million euros impact on OED, attracting around 6 and 8 percentage points respectively from organic growth. The main impacts and challenges at the revenue level came in the form of lower overall commercial activity, derived from lockdowns and travel restrictions. We saw lower handset sales and lower service revenues as a result of almost absent roaming due to travel bans. Service revenues were also affected by a decline in mobile prepaid, a reduction in B2B due to delayed IT projects and certain contract renegotiations, lower SME revenue and overall promotional activity and discounted tariffs. Nevertheless, during the quarter we leveraged our strengths to exploit opportunities presented by the crisis. We took proactive steps to improve our OPEC, with as much as 50% of the negative top line effects being absorbed through lower direct and commercial expenses, while successfully controlling churn that was down by 40 basis points versus Q2 2019. Qapex savings, thanks to our flexible operating business model, also supported financial performance. And meanwhile, digitalization has proven key during the pandemic, as shown by the 12 percentage point increase in the digital channel mix in just one quarter to 39% in our core four markets, and by the high rate of growth in the use of online apps in Brazil. I would like to note that to date we have seen a sharp recovery in post lockdown markets, with a strong resurgence in commercial activity as stores reopen. We also believe that the COVID-19 crisis is likely to significantly accelerate the digitalization shift, and we're already registering an increase in underlying demand for cloud, cyber and health services. Moving to slide nine. As previously stated, we are seeing a clear path to recovery. Year on year revenue growth trends are getting better by the month, in line with the gradual lifting of COVID-19 restrictions, as you can see in our Spanish operations. We can therefore identify May as the month worst affected by COVID-19. As such operating trends remain positive, -COVID-19. Looking ahead, our intention is to further leverage capabilities and infrastructure to capitalize on accelerating trends in IoT, big data and ICT, among others. Moving to slide nine, we show how a year on year revenue decline of 1.8 billion euros translated into a 1.1 billion euro drop at the level, as a result of measures implemented by the group to mitigate the negative effects of COVID-19. Resulting in outstanding cost management. As such, OPEC's decline minus .7% in reported terms and minus 4.9 in organic terms. Moreover, the OEPA decline was further reduced to 0.5 billion euros in terms of OEPA minus CAPEX, thanks to the efficient and effective management of investments during the crisis. All this outlines the resilience of our business in the middle of the deepest economic crisis in this century. On slide 11, we highlight the impact of our proven execution. In Q2, we moved at pace in the operational management of our four core markets, delivering growth year on year in 80 minus CAPEX to revenue ratio, despite the COVID impact. At the regional level, it is worth highlighting the growth posted in both Spain and Brazil are our two largest operations. Turning to slide 12, Telefonica Spain's Q2 results were impacted by strict government measures introduced in response to COVID-19. Throughout this period, we leveraged the strength of the largest -the-home network in Europe to provide reliable service for our customers, while leading efforts to support the wider society. Since the lifting of restrictions and supported by a refreshed offering and football competition restart, commercial activity recovered throughout the quarter. Fiber net ads in May were 21 times higher than in April, and mobile and TV improved as well. This is reflected in net ads recorded across all types of accesses. Our segmented offering and differential assets are reflected in the growth seen across different tiers of the retail market, as well as in the fiber wholesale arena. On the other hand, despite the challenging environment, our strategy to offer added value to our customers allowed us to maintain robust ARPU and limit churn in our conversion base. In slide 13, the recovery in commercial activity was reflected in improving revenue trends throughout Q2 2020. For example, the -on-year drop in service revenue in June was half of the level of the decline recorded during April and May. In this environment, the company prioritized cash generation and showed significant resilience. Thanks to strong OPEX and CAPEX management, we achieved -on-year growth in both OEPA minus CAPEX and OEPA minus CAPEX over revenues for Q2. However, investments in growth continued at pace, with 51% of total CAPEX devoted to next-generation deployment, 12 points above Q2 2019, translating into 228,000 new premises passed in Q2. Given our leading position in Spain, where we have a well-invested and diversified business, we are confident that we are very well positioned to continue to deliver solid cash flow generation going forward. Moving to slide 14, Telefonica Deutschland delivered a solid operational performance, despite experiencing some COVID impacts throughout the quarter. Following the reopening of O2 shops from the end of April, footfall and trading dynamics have been experiencing a gradual recovery. O2 contractual improved by .1% -on-year in Q2, and owned brand ARPU grew by .7% -on-year in the month of June. In terms of financial performance, the OTA minus CAPEX over revenues ratio remained broadly stable versus Q1 2019, despite the full COVID-19 impact, demonstrating the robust profitability and cash generation of the business. Finally, the company won several industry awards during the quarter, including a very good rating in Connex Magazine's 2020 Fixed Network Test and Best M&O in Telecom Handles Reader's Choice Awards. Moving on to slide 15 and the UK business. Despite being in lockdown for almost all of the second quarter, O2 remains the UK's number one for customers, growing its base by .5% to 34.1 million. Contract churn stood at .9% as customers continued to value our award-winning customer service, network resilience, brand and unique propositions. Looking at our financial performance, revenue declined by .8% -on-year, primarily due to COVID-19 impacts on roaming and calls, and OTA declined by .1% excluding special factors in the prior year. Given the situation, we have maintained our OTAX and CAPEX flexibility to manage operating cash flow, which remained broadly stable in the first half of the year, whilst continuing to invest in our network to boost 4G and 5G coverage and capacity. Let's now move to the performance of our Brazilian operations on slide 16. Even though commercial activity was highly impacted by lockdown restrictions during the quarter, with the gradual reopening of stores in June, we are starting to see signs of recovery. Mobile contract gross ads increased 73% in June compared to April, and we reached a new all-time record in -the-home net ads in June. This confirms Vivo's high-quality value proposition and demonstrates our ability to steer our business through a difficult environment. In terms of our financial performance, despite COVID-19, we delivered a resilient service revenue trend and notable improvements in profitability, with an OTA minus CAPEX margin above 25% for the first six months of the year. Specially remarkable is the free cash flow generation in Brazil, which has increased by .5% in the first half of the year,