Telefónica’s Net Profit Totals 2,056 Million Euros up to June and Revenues Return to Organic Growth in the Second Quarter

César Alierta, Executive Chairman, has stressed the "significant progress” made in Telefónica’s (NYSE:TEF) (LSE:TDE) on-going process of transformation during the second quarter of 2013. A programme which places the company in "a strong position both in terms of business and financial performance” and has allowed Telefónica to take an important step towards "forming a leading operator in Europe’s largest market”. The results of the first six months are in line with internal estimates allowing the company to reaffirm annual operating and financial targets.

• Telefónica Group’s revenue returned to growth in organic terms for the first time since the first quarter of 2012. Revenues increased 0.5% year-on-year during the second quarter of 2013 driven by a strong acceleration in Latin America, which grew by double-digits in the same period (+10.4% yoy in organic terms), and improving trends in Europe. As a result, between January and June, Telefónica’s revenue totalled 28,563 million euros and remained virtually stable in organic terms (-0.5%).
• For the third consecutive quarter, and as a result of the solid execution of the transformation strategy implemented over the last year as well as appropriate cost saving and efficiency boosting measures, OIBDA and OIBDA margin remained virtually stable in organic terms. At the end of June, OIBDA reached 9,421 million euros (-0.4%) and the company maintained high levels of profitability with an OIBDA margin of 33%.
• In reported terms, the evolution of the aforementioned items were particularly affected by exchange rate fluctuations, mostly by devaluation in Venezuela and depreciation of the Brazilian real and the Argentinian peso, which subtracted more than five percentage points from revenue and OIBDA performance.
• Latin America accounts for 51.4% of the group's consolidated revenue with all of the countries in the region making a positive contribution to this item in the second quarter of the year.
• Including the disposals of 40% in Central America, 100% in Ireland and Inversis, carried out after closing the second quarter, Telefonica´s net debt totals 48,614 million euros. This represents a leverage ratio of 2.36 times net debt over OIBDA and places the Group’s net debt very near its objective of <47,000 million euros in 2013. To add to this significant progress in financial flexibility the cash flow generation reached over 1,900 million euros in the second quarter of the year.
• Telefónica’s financing activity amounted to approximately 7,800 million euros in the first quarter of the year. Therefore, as of June 30th the Company maintains a debt maturity profile that thanks to its liquidity position is covered for the next 2 years.
• At the end of June, the Telefónica Group’s customer base reached 317.3 million accesses (+2%) out of which more than 78% are mobile accesses (249.5 million). The second quarter saw 2.1 million net mobile contract customer additions resulting in mobile contract customers already amounting to 85 million (+8.1%). Noteworthy is the considerable increase in smartphones, with a record net gain in the quarter of 8.2 million or three-times the figure for the first quarter of the year. Smartphones already reached a penetration rate of 24% of mobile accesses.
• Telefónica Group continues to progress, via its Telefónica Digital and Telefónica Global Resources units, on its transformation process towards becoming a Digital Telco with a completely global business model. The launch of the first handsets running Firefox in Spain and their arrival in Colombia and Venezuela, expected during this quarter, is further evidence of the continuing success of this programme.
• In Spain, Telefónica continues to successfully execute the transformation needed to improve its competitive positioning and business parameters. In this respect, at the end of June, Movistar Fusión reached 2.2 million customers and is fostering new customer acquisition and the incorporation of new services, which already account for 56% of the gross additions for the quarter. At the same time, the performance of total revenue is improving (excluding handset sales) and Spain is continuing to show profitability levels which are a benchmark in the sector, with OIBDA margin growth of four percentage points at the end of June.
• Brazil improved revenue trends during the second quarter (+3.1% and +4.8% excluding regulatory impacts) and strengthened its position in the higher value segments with contract accesses growing 20% yoy in the semester. In this regard, particularly noteworthy was the 58% share of net contract additions achieved by the Company in the second quarter which also saw a strong acceleration in net fixed broadband additions.
• Between January and June 2013, the company invested 3,903 million euros, including 834 million euros for purchasing spectrum in the United Kingdom, Uruguay, Spain and Brazil. 84% of the total investment effort was allocated to growth and transformation activities.

Telefónica presented its results for the first quarter of the year today. During this period, the company´s net profit was 2,056 million euros, virtually unchanged versus the same period the previous year (-0.9%). During the second quarter of 2013, Telefónica made significant progress in the transformation process that the company is implementing. The return to organic revenue growth in the quarter, the stabilisation of high levels of profitability, and the significant progress made in financial flexibility (net debt reduced by 10 billion euros since June 2012) demonstrate that the transformation programme is starting to have a reflection in the improved evolution of both operating and financial variables.

According to César Alierta, Telefónica’s Executive Chairman, all the above "has placed us in a strong position in terms of both business and financial evolution” which has been key for Telefónica to take the necessary step towards "forming a leading operator in Europe’s largest market”. Thus, the execution of the announcement made last Tuesday will make Telefónica the leading operator in terms of accesses, network quality and distribution network in three of its main markets: Brazil, Germany and Spain. At present, these markets combined generate more than 54% of the Group’s revenue and represent 50% of the total access base.

During the second quarter of the year, Telefónica continued to advance on several initiatives, within the transformation strategy which is being executed since last year and which is delivering visible results each quarter, despite a challenging economic backdrop and a highly competitive environment in key countries. On the one hand, the Company continued to adapt to customer needs and to stay ahead in a changing environment, with a refreshed commercial offer which allows to increase customer satisfaction and to reduce churn. On the other hand, progress continued to be achieved on the simplification of the operating model, delivering higher levels of efficiency and quality.

As a result, revenues, which totalled 28,563 million euros between January and june, turned back to post a year-on-year organic growth in the second quarter, boosted by the acceleration of the commercial activity, especially in Latin America, driven by a increasing demand for smartphones. OIBDA (9,421M€) was relatively stable year-on-year (-0.7% year-on-year in organic terms in the second quarter; -0.4% in the first six months) reflecting the savings and efficiencies achieved, and despite the higher commercial effort, while free cash flow significantly improved both year-on-year and quarter-on-quarter. At the same time, The Company continued to prioritize investment towards growth activities and to reduce debt. Furthermore, first quarter results, in line with forecasts, allow the company to reaffirm annual operating and financial targets.

317 million accesses

Telefónica managed 317.3 million accesses at the end of June, up 2% year-on-year, affected by the sale of the fixed business assets in the UK (720 thousand accesses) in the second quarter, the disconnection of 114 thousand mobile contract accesses in Czech Republic and the application of more restrictive accounting criteria for the prepay segment.

Mobile accesses stood at 249.5 million, up 2% compared with June 2012, driven by the contract segment, which accelerated its growth to 8% year-on-year and now accounts for 34% of total mobile accesses The Company strengthened its position in this high value segment and during the second quarter ramped up its pace of customer capture and commercial activity, particularly in smartphones, with net contract additions of 2.1 million, the highest since the third quarter of 2011.

Mobile broadband accesses stood at 63.3 million at the end of June, posting the largest year-on-year growth since the second quarter of 2012 (+41%), almost 7 percentage points higher than the first quarter and increasing its penetration rate up to 25% of mobile accesses (+7 percentage points year-on-year). This strong commercial activity continued to be underpinned by the significant increase in smartphones, with a record of 8.2 million net additions in the quarter, three-fold the figure in the first quarter and more than double the figure in the same period of previous year. The smartphone penetration rate stood at 24% of mobile accesses in June 2013.

Retail broadband accesses totalled 18.3 million at the end of June and improved its growth up to 2% excluding the impact of the sale of the assets of the fixed business in the UK. Net additions in the quarter stood at 165 thousand customers, 4.4 times more than in the first quarter and 1.9 times more than in the same period of 2012.

The acceleration in commercial activity in the quarter was mainly driven by Telefónica Latinoamérica, with mobile contract net adds rising by 44% compared with the first quarter of 2013 and by 64% compared with the second quarter of 2012, reflecting the focus on high-value customers, especially on smartphones. There was also a marked improvement in the operating performance of the fixed business, mainly driven by broadband, with net adds in the quarter 1.6 times higher than in the January-March period, to reach 214 thousand accesses.

Income statement analysis, entry-by-entry

Before going into the details of the income statement, it is important to note that Atento Group deconsolidated its results from the Telefónica Group as of the end of November 2012 (following the disposal of the Company during the fourth quarter of 2012), therefore affecting year-on-year comparisons of Telefónica's reported financial results. The results of the UK fixed business assets were also excluded from 1 May following the sale of its assets in April 2013.

Year-on-year performance was also negatively impacted in the first half by exchange rate fluctuations, mainly due to the devaluation of the Venezuelan bolivar from 1 January 2013, and the depreciations of the Brazilian real and the Argentine peso. Thus, in the first half and in the second quarter exchange rates reduced revenue growth by 5.5 percentage points, while the impact on OIBDA was -5.4 percentage points. Moreover, changes in the perimeter of consolidation reduced revenue growth by 1.8 percentage points in the first half and reduced OIBDA growth by 1.2 percentage points.

Revenues in the first half of 2013 totalled 28,563 million euros, down 7.8% year-on-year (-6.8% in the quarter). In organic terms, however, revenues started to grow again in the quarter (+0.5% year-on-year), limiting the year-on-year decline in the first six months to -0.5%. This acceleration was fuelled by Telefónica Latinoamérica, where growth accelerated by 3.5 percentage points to 10.4% year-on-year in April-June, whilst Telefónica Europe improved by 1.7 percentage points. Excluding the negative impact of regulation, consolidated revenues in organic terms would have grown by 1.0% compared with the first half of 2012, accelerating its growth in the second quarter up to 2.1%.

By region, Telefónica Latinoamérica is the Group's growth engine, accounting for 51.4% of consolidated revenues in the first half of the year while Telefónica Europe and Telefónica España's contributions fell to 46.9% and 23.0%,respectively.

Mobile data revenues are the other key lever for the Telefónica Group's growth. Another quarter maintained a solid growth, rising by 9.8% year-on-year in organic terms (+9.6% in the first half) and accounted for 36.4% of mobile service revenues in the year (up 3 percentage points compared with the first half of 2012). Non-SMS data revenues growth ramped up sequentially to 22.1% year-on-year in organic terms (+22.0% in the half year) and now account for 63% of total data revenues.

Cost saving and efficiency initiatives maintain high profitability

Operating expenses amounted to 19,774 million euros in the first six months of 2013, posting a year-on-year decline of 0.1% in organic terms (-7.0% reported) on the back of the cost savings from the efficiency initiatives implemented.

Breaking it down by components, Supplies decreased by 1.5% year-on-year in organic terms in the semester (-6.8% reported), due to lower interconnection costs and handset purchase costs at Telefónica. Personnel costs increased 4.4% in organic terms in the year (-15.5% in reported terms) mainly due to higher costs in Latin America stemming from the negative impact of inflation in some countries in the region. Finally, subcontract expenses fell 1.0% year-on-year in the first half in organic terms (-1.6% reported) due to the reduction in commercial costs in Europe, mainly in handset subsidies and advertising, as a consequence of the new commercial strategy launched in 2012, and savings due to efficiency programs and process simplification.

The average headcount was 131,882 employees, down slightly compared with the first half of 2012 (-3.5%).

Gains on sales of fixed assets in the first half of 2013 amounted to 152 million euros, of which 126 million euros were booked in April-June, mainly associated with the capital gain from the disposal of the assets of the fixed business in the UK (73 million euros), the capital gain from the sale of the stake in Hispasat (21 million euros) and the sale of non-strategic towers in Latin America (35 million euros of impact in OIBDA), partly offset by the impairment of Telefónica Ireland (16 million euros).

Operating income before depreciation and amortisation (OIBDA) reached 9,421 million euros, virtually unchanged in organic terms (-0.4%) compared with the same period in 2012 (-9.7% reported. The OIBDA margin stood at 33.0% in the first half, stable compared with the same period in 2012 in organic terms, highlighting the solid execution of the Company's transformation strategy (cost saving and efficiency initiatives), and the benefits of Company’s scale and diversification.

Depreciation and amortisation (5,105 million euros in the first half, -0.5% reported) grew by 4.5% year-on-year in organic terms, while operating income (OI) totalled 4,316 million euros in the first half, down 5.4% year-on-year in organic terms. Share of profit (loss) of investments accounted for by the equity method amounted to 28 million euros in the first half.

Net financial expenses amounted to 1,399 million euros in the first half of the year, of which 47 million euros were due to negative forex differences. Excluding this effect, net financial expenses fell 13.6% compared with the same period in 2012 thanks to the reduction in average debt in the period (-8.5% compared with June 2012) and the lower cost of gross debt. This implies an effective cost of debt excluding exchange forex of 5.23% over the last 12 months.

Corporate income tax in the first half of 2013 stood at 751 million euros, down 21.8% year-on-year. Thus, the effective tax rate in the semester decreased to 25.5%.

Profit attributable to minority interests reduced first-half net profit by 138 million and was down 24.2% year-on-year mainly as a result of the lower profit attributed to minority interests in Brazil, affected by the exchange rate.

As a result, consolidated net income totalled 2,056 million euros, -0.9% compared with the first half of 2012 while basic earnings per share decreased by 0.7% year-on-year to 0.46 euros.

Investment efficiency, aimed at transformation and growth

With regard to investment, the Company continues to focus on reassigning resources to growth and transformation activities (84% of the total), leveraging on the efficiencies achieved in areas such as IT, procurement, improvement of quality indices and churn reduction. CapEx in the first half totalled 3,903 million euros (+6.7% year-on-year) and included 834 million euros relating to the acquisition of spectrum; in the UK (671 million euros) and Uruguay (24 million euros) in the first quarter and in Spain (65 million euros), the UK (47 million euros) and Brazil (28 million euros) in the second quarter.

Consequently, operating cash flow (OIBDA-CapEx) rose 3.4% year-on-year in organic terms in the first half, continuing the growth trend initiated in the fourth quarter of 2012.

Financial position

As a result, free cash flow amounted to 1,451 million euros in the first six months of 2013 (1,908 million euros in the second quarter), including spectrum payments of 1,110 million euros. Excluding this impact, free cash flow would have totalled 2,562 million euros, up 19.0% year-on-year as a result of lower interest payments and the positive change in working capital.

Net financial debt stood at 49,793 million euros at the end of June 2013, down 8,517 million euros compared with June 2012 and 1,466 million euros versus December 2012. Including post-closing events (40% sale in Central America’s assets, sale of 100% of T. Ireland and Inversis), net debt would stand at 48,614 million euros.

The leverage ratio (net debt over OIBDA) for the past 12 months stood at 2.40 times at the end of June 2013. The ratio is reduced to 2.36 times once considered post-closing events (40% sale in Central America’s assets, sale of 100% of T. Ireland and Inversis).

In the first half of 2013, Telefónica's financing activity, excluding short-term Commercial Paper Programmes activity, has been intense through bond and loan markets executing operations for an amount close to 7,800 million equivalent euros. The financing activity was mainly focused on financing in advance debt maturing in 2013 and beyond and on smoothing the debt maturity profile at the Holding level for the following years while strengthening liquidity position. Therefore, as of June 30th the Company maintains a debt maturity profile that thanks to its liquidity position is covered for the next 2 years.

Telefónica maintains total undrawn committed credit lines for an amount over 14,000 million euros, with over 12,350 million maturing in more than 12 months.

At the end of June 2013, bonds and debentures represented 71% of the consolidated financial debt breakdown, while debt with financial institutions represented 29%.

Telefónica Digital and Telefónica Global Resources

Additionally, Teléfonica Digital has further progressed with the launch of new services which continue to transform the Company towards a digital telco operator, to capture all the growth opportunities in this environment.

During the second quarter, there were several new developments regarding Financial Services in Latam and Europe. MFS, a joint venture with Mastercard, was launched in May 2013 under the "Zuum” brand the first mobile payment service in Brazil. An agreement was also reached with Caixabank and Banco Santander to establish the first joint venture in Europe between financial institutions and telcos to create new digital services. A global agreement was reached with Samsung, who will be the first handset manufacturer to integrate with Telefónica’s billing capabilities. In addition, in May, Telefónica signed an agreement with Dell to deliver the broadest pay-as-you-go mobile broadband service for notebooks and tablets across Europe, through the "Dell Net Ready” solution.

At the start of June, Telefónica Digital announced the creation of "Eleven Paths”, a new center for innovation in Security services. "Eleven Paths” will adopt a hothouse approach with the aim of radically introduce innovation in the way security products are developed in Telefonica. On July 2nd the first Firefox OS handset was launched in Spain. Next launches of Firefox handsets will take place in Colombia and Venezuela.

Telefónica Global Resources has further advanced in the execution of its priority projects for the year, which allow accelerating the transformation into a fully global model.

The global Network and Operations unit contributed to deploy LTE sites, with strong activity in Brazil and Germany during the quarter.

In the global IT area it is worth to highlight the progress made in our infrastructure consolidation strategy, both in Europe and Latin America. As part of the Company's simplification process, following an inventory of the over 1,100 applications to be withdrawn, approximately 300 have now been decommissioned, in line with forecasts, which will lead to a less complex IT, better time-to-market and lower usage of resources.

With regard to mobile devices, the global area continued to focus on achieving a more balanced vendor map. As such, it is important to note as we have mentioned above, that Movistar España launched the first world FireFoxOS device at the beginning of July. Also noteworthy are the agreements with different relevant industry players to promote the sale of various smartphones categories and operating systems in our markets.