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SYS-CON MEDIA Authors: Elizabeth White, Mike Kavis, Carmen Gonzalez, Pat Romanski, Liz McMillan

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Telefónica Reports a Net Profit of 692 Million Euros as of March and Reiterates All of Its Operational and Financial Guidances for 2014

The Executive Chairman of Telefónica (NYSE:TEF) (LSE:TDE), César Alierta, emphasised that “our performance in the quarter was in line with the targets set for the year. First quarter results show visible progress in the execution of the strategy announced for 2014, based on further reinforcing the differentiation of our products and services through a non-replicable infrastructure. In this sense, we are making significant investments, accelerating our network modernization”.

  • The Company reaches a leverage ratio of 2.30 times OIBDA after having reduced its net debt by 2,657 million euros in the first quarter to bring it down to 42,724 million euros.
  • The Company’s earnings grew organically (+1.5%) for the fourth quarter running to stand at 12,232 million euros at 31 March 2014. It is worth highlighting the growth of our mobile data earnings (+8.8%), which represent 40% of total mobile revenues, and the strong growth of our high-value client base, coming from mobile contract (+9%), smartphone penetration and also of our fibre and pay TV operations.
  • OIBDA totalled 3,929 million euros and accelerates its organic growth (+0.5%) compared to the previous financial year thanks to the sustained growth of earnings and the success of the expenses control and efficiency measures implemented by the Company.
  • The variation in exchange rates had an impact on our 1Q14 results by bringing year-on-year earnings growth down by 11.8 p.p. and reducing OIBDA by 11.7 p.p. Earnings were also affected by perimeter changes, especially by the sale of Telefónica Czech Republic, which brought them down by 3.1 p.p., with OIBDA falling by 3.7 p.p.
  • The acceleration of our network modernization reflects in a significant organic CapEx increase (+29.5%) compared to the first quarter of 2013. Investments related with transformation and growth accounted for over two thirds of the total CapEx figure in the first quarter.
  • Despite this significant organic increase of CapEx and the effect of exchange rates and perimeter changes, the Company reported a solid cash flow generation, with a relevant improving year-on-year by 796 million euros, the largest in a first quarter since 2011.
  • The results reported by Telefónica Spain reflect the continued recovery of the business. Earnings show an important improvement in the downward trend in 3.7 p.p. compared to the previous quarter and an improved commercial development, mostly in fibre, pay TV and an increased preference for quality services. Movistar Fusión remained the fundamental lever for growth in Spain with a customer base of 3.2 million.
  • Telefónica Brazil also continued to strengthen its leadership in the highest value segments thanks to the competitive advantage it enjoys in network coverage and quality and to the universal appeal of its commercial offerings. This translated into an organic earnings growth of 2.9% (ex-regulation) and once more highlights the Company’s net profit performance in the contract segment (1.2 million accesses) and with respect to fibre rollout, with the current figure of 1.5 million homes passed.
  • Telefónica’s market financing activities during the first quarter ended it at around 5,700 million euros, meaning that the Company finds itself in a comfortable position regarding liquidity from which to tackle the next round of debt payments.

Telefónica’s 1Q14 results are in line with the Company’s internal earnings, OIBDA and CAPEX over sales estimates and therefore reiterates its operational and financial targets for the year, including the dividend. During the first three months of the year Telefónica moved forward with the implementation of its transformation strategy and operating model, the aim of which is to maximise value creation and make the most of the growth opportunities offered by the digital revolution.

According to Telefónica Chairman César Alierta, “we continue to improve our financial flexibility, posting the strongest first quarter cash flow generation in the last three years after registering a solid year-on-year improvement, despite higher investments, the negative impact of exchange rates and asset disposals. This allowed to register a further decline in net debt another quarter, bringing total reduction to around 16 billion euros over the last 7 quarters”.

In this respect, the results presented today by Telefónica reflect the improvement in the organic growth of its earnings and OIBDA thanks to the strategy of attracting high-value customers, the efforts being made to simplify its operation and cost savings. It is also worth highlighting the continued reduction of the Company’s debt level, which has fallen by 2,657 million euros with respect to December 2013 to stand, at the end of March of this year, at 42,724 million euros. Were operations subsequent to the closure of the first quarter to be included (sale of Telefónica Ireland), the debt would stand at 41,944 million euros. Therefore, at the end of March the debt ratio (net debt over OIBDA) stood at 2.30 times, and this would be reduced to 2.27 times were the aforementioned operations carried out after the close of the quarter to be included.

Regarding accesses, at the end of March they totalled 313.1 million, 1% less than one year ago, due precisely to the deconsolidation of the business in Czech Republic and to the sale of the residential business in the UK, without the effect of which they would have enjoyed a year-on-year growth of 2%.

By segments, mobile accesses increased by 3% year-on-year in organic terms to 247.5 million at the end of the quarter thanks to strong contract access growth (+9% organic), accounting for 35% of the total (+1 percentage point year-on-year). Particularly noteworthy is T. Brasil’s ongoing progress in capturing high-value customers (+28% year-on-year in contract customers, with net additions in the quarter up 70% year-on-year). Smartphone (all with a data plan attached) penetration stood at 30% at the end of March 2014 (+9 percentage points year-on-year) and retail fixed broadband accesses totalled 17.6 million, up 2% vs. March 2013 in organic terms. Pay TV accesses (3.6 million) rose 8% year-on-year, highlighting the performance of T. España (consolidating its recovery trend for the second quarter in a row) and the double-digit year-on-year growth of T. Hispanoamérica and T. Brasil.

According to César Alierta, “we are building a more sustainable growth model leveraged on higher customer satisfaction. The acceleration in the modernisation of our networks is reflected commercially in the evolution of our customer base; contract mobile accesses grew almost double-digit year-on-year underpinned by the acquisition of almost 6 million smartphone customers, doubling the figure of the first quarter of 2013 while in the fixed business, fibre customer base increased 90% year-on-year. As a result, the value of our customer base has increased due to both the improved ARPU and the higher loyalty, leading to a longer average customer lifetime”.

Apart from perimeter changes, exchange rate fluctuations, in particular the depreciations of the Brazilian reai and the Argentine peso along with the implicit devaluation of the Venezuelan bolivar, negatively impacted financial results. Thus, in the January-March period exchange rates deducted 11.8 percentage points to year-on-year revenue growth and 11.7 percentage points to OIBDA growth.

Revenue organic growth for the fourth quarter in a row

First quarter revenues totalled 12,232 million euros in January-March 2014, up 1.5% year-on-year in organic terms (-13.5% reported), posting positive growth for the fourth quarter in a row and accelerating vs. full-year 2013. Excluding the negative impact of regulation, organic revenues grew 3.4% compared with January-March 2013.

By services, mobile data revenue growth accelerated compared with the previous quarter (+8.8% year-on-year in organic terms; +7.8% in the fourth quarter of 2013), now accounting for 40% of mobile service revenues, up 2 percentage points compared with the first quarter of 2013. It is also noteworthy the performance of non-SMS data revenues in January-March 2014, improving year-on-year growth to 23.6% in organic terms and already accounting for 71% of total data revenues (+8 percentage points year-on-year).

Consolidated operating expenses totalled 8,548 million euros in the quarter, up 1.5% year-on-year in organic terms (-13.0% reported), with the pace of year-on-year growth easing for the second consecutive quarter due to strict cost control and efficiency measures, despite the high level of commercial activity.

Operating income before depreciation and amortisation (OIBDA) in the first quarter of 2014 amounted to 3,929 million euros, up 0.5% year-on-year in organic terms (-14.0% reported), with growth accelerating vs. full year 2013 and posting positive year-on-year growth for the second consecutive quarter. This performance was underpinned by sustained revenue growth and cost containment measures, along with efficiencies and synergies from the new operating model. Excluding the adverse impact of regulation, OIBDA grew by 1.9% compared with January-March 2013 in organic terms.

The OIBDA margin stood at 32.1% at the end of the first quarter, virtually stable year-on-year in organic terms compared with the same period of 2013 (-0.3 percentage points). Operating income (OI) in the first quarter of 2014 stood at 1,838 million euros, up 5.2% year-on-year in organic terms (-11.0% reported).

As a result, consolidated net income in the first quarter amounted to 692 million euros (-23.2% year-on-year; 16.6% underlying) and basic earnings per share amounted to 0.15 euros per share (-27.0% year-on-year; -20.0% underlying).

CapEx up to March totalled 1,555 million euros (-19.9% year-on-year) and included 187 million euros relating to the acquisition of spectrum in Colombia and Central America (695 million euros in the first quarter of 2013, mainly in the UK). In organic terms, investments rose 29.7% year-on-year, with more than 69% of total investments devoted to business transformation and growth.

As a result, free cash flow amounted to 339 million euros in the first quarter, the highest since 2011, posting a significant year-on-year improvement of 796 million euros.

Financing activity of 5,700 million euros in the quarter

In the first quarter of 2014, Telefónica's financing activity through bond and loan markets stood at around 5,700 million equivalent euros. This activity was mainly focused on strengthening the liquidity position and smoothing the debt maturity profile of Telefónica S.A. for the following years. Therefore, as of the end of March, the Group maintains a comfortable liquidity position to accommodate next years debt maturities. In Hispanoamérica, Telefónica's subsidiaries tapped financing markets for approximately 124 million equivalent euros in the first quarter of 2014. Also noteworthy is the 500-million-euro bond placement by T. Deutschland in January.

Telefónica maintains total undrawn committed credit lines with different credit entities for an approximate amount of 12,560 million euros, with around 11,250 million maturing in more than 12 months.

Digital Services and Telefonica Global Resources

In the new area of the Chief Commercial Digital Officer, recently established to bring digital services to the core of our businesses, we could highlighted in the B2B area, the M2M agreement signed by Telefónica with JCDecaux, the world’s leader in outdoor advertising, to bring connectivity and new digital features to a new range of smart M2M powered solutions for urban environment in Europe and Latin America; and the one reached with Tesla, an industry-leader of in-car telematics. Thus, M2M revenue grew by more than 50% year-on-year in organic terms in the first quarter.

With regards to Cloud services, revenue advanced by more than 20% organic year-on-year in the first three months of the year, gradually adding value to our offering. Information Security revenues grew slightly above 20% organic year-on-year in the quarter fueled by strong momentum in “CyberSecurity”.

It should be also mentioned some strategic investments made as the creation of “Axonix”, the first mobile Advertising exchange platform owned and powered by a mobile operator; the one reached with “Saluspot” for E-health services, which enables to offer free online health advice; and the Spanish cloud computing start-up “eyeOS” was acquired, enabling Telefónica to offer an open-source desktop virtualisation service.

In Video, within the area of Consumer, Telefónica acquired for Spain exclusive content rights in Moto GP and Formula 1. Thus, the strategic focus on fostering Pay TV growth is delivering positive results with revenues growing in organic terms by 12% year-on-year and accesses by 8% year-on-year in the quarter, and increasing market share in the main markets where the Company is present.

Additionally, in April the brand of the Digital Financial Services (“Yaap”) to be provided in Spain by the joint venture established with CaixaBank and Santander was announced. Two services will be launched in the coming months, “Yaap Shopping”, a virtual showroom helping small businesses, and “Yaap Money”, a peer to peer service that will enable people to send money from one mobile device to another.

Telefónica Global Resources continued driving the Company's technological transformation during the quarter, accelerating network modernisation and simplification, ensuring a higher quality of infrastructure and systems and enhancing the differentiation of products and services. In the global Network and Operations unit sharply accelerated the rollout of ultra-broadband infrastructure. Homes passed with fibre amounted to 5.8 million, around 80% more than in March 2013, and LTE sites deployment increased by more than 3 times year-on-year to reach more than 10,200 sites. The global IT unit is developing the Company's IT transformation strategy through: (i) consolidation, focusing on the Data Centres, technical infrastructure and corporate applications; (ii) simplification and transformation of applications; and (iii) support for transformation towards a Digital Telco.

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