SYS-CON MEDIA Authors: Trevor Parsons, Sean Houghton, Glenn Rossman, Ignacio M. Llorente, Xenia von Wedel

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Telefónica Achieves a Net Profit of 1,903 Million Euros in the First Semester of the Year and Confirms Its Operating and Financial Targets for 2014

The company accelerated its commercial activity in Spain, where the radical transformation undertaken in recent years and the improvement in the economic conditions should reflect in a gradual revenue improvement in the coming quarters. Telefónica’s Executive Chairman, César Alierta, said: “first-half results started to reflect the benefits from the investments in network modernisation carried out in recent quarters, which are enabling us to further differentiate our offering in key markets.

  • Revenue in the first semester of the year increased by 1.4% in organic terms, to 24,957 million euros. In the second quarter, revenue grew 1.3% organically and showed the acceleration of revenue growth in mobile data (+9.2% organic) and non-SMS data (24.1%).
  • The company has also made a significant commercial effort in order to capture new growth opportunities: OIBDA reached 8,055 million euros in the period January-June and remained stable compared to recent quarters (-0.1% organic year-on-year in the semester).
  • First semester results are affected by exchange rate variations, which subtract 10.9 p.p from year-on-year growth of revenue and OIBDA. They are also affected by changes in the perimeter, particularly by the sale of Telefonica Czech Republic, which reduced revenue by 3.1 p.p. and OIBDA by 3.7 p.p.
  • Telefónica continues to focus on technological transformation and modernisation of its networks, which translates into a significant increase in investment; this amounted to 3,523 million euros (+27.2% organic) in the first half of the year.
  • Free cash flow grew significantly in the first half of the year to 1,664 million euros (+14.7%) and consequently the company's financial flexibility also improved. Similarly, net financial debt fell by 1,590 million euros in the semester. Including the sale of Telefonica Ireland, completed on the 15th of July, net debt stood at 42,961 million euros.
  • In Spain, consolidation of revenue together with a radical change of commercial activity is the basis of the change in business dynamics in Spain. The results for the second quarter confirm the success of the new commercial offering and therefore, of the increase of sales in high value services, as shown by the net gain of 0.6 million in pay TV customers and the net quarterly gain in fibre, of 182,000 access. At the end of the quarter, fibre coverage stood at 7.4 million premises, almost double the figure in June 2013.
  • Telefónica Brazil, which for the fourth consecutive quarter has captured more than 60% of net gains in the contract market, continues to improve its competitive position, thanks to its quality of service improvement strategy and its commitment to innovation in its commercial proposals.

In the first six months of 2014 Telefónica further progressed in its transformation towards a more sustainable business model, with lower customer churn and leveraged on higher quality services. This strategy resulted in customer value increase, both in average lifetime extension and ARPU improvement. Thus, César Alierta, Executive Chairman of Telefonica, explained how the acceleration of the commercial activity in the second quarter reflects the offering differentiation in Telefonica’s key markets “with net additions of 2 million mobile contracts, 5 million smartphones and more than six hundred thousand pay TV customers. All of which are high-value services contributing to boost average revenue per customer and reduce churn”. He also said that Telefonica “continued to strengthen its competitive position through higher investments which resulted in 10.5 million premises passed with fibre and an expansion of LTE coverage to almost half of the population in our European markets and one third of the population in Latin America”.

Commercial activity in high value segments and services was particularly noteworthy and gradually flowed into revenues, which continued to deliver organic growth. OIBDA remained stable despite higher commercial expenses, which are the cornerstone of future growth, thanks to strict cost control and operational simplification. In addition, the solid cash flow generation in the first half along with portfolio management optimisation policy, allowed further financial flexibility improvement. César Alierta also highlighted: “we continued executing our asset portfolio optimisation policy, enabling us to reduce debt to below 43 billion euros including the disposal of Ireland, completed in July”.

315 million total accesses

Total accesses grew 2% year-on-year in organic terms to 315.8 million as of June 30th (excluding T. Czech Republic following its sale on 1 January) thanks to the increased commercial intensity in the last three months. Once again, growth was driven on the one hand by higher value segments and growth levers, such as mobile contract segment (especially smartphones), pay TV and fibre, and on the other hand by T. Hispanoamérica and T. Brasil. Moreover, ongoing investment efforts resulted in 10.5 million premises passed with fibre and increased adoption of LTE services. This increasing differentiation of service quality translated into higher customer satisfaction, reflected in quarter-on-quarter improvement of total churn (-0.3 percentage points) which posted better performance across different services.

The pace of fibre deployment over the last three months significantly accelerated to reach 1.3 thousand premises passed (848 thousand in the first quarter). At the end of the quarter, fibre coverage stood at 7.4 million premises (5.0 million households), almost double the figure in June 2013, thanks to an intense commercial activity in Spain and the improvement in the economic condition.

In the first half of 2014 exchange rate year-on-year evolution negatively impacted financial results, in particular the depreciations of the Brazilian real and the Argentine peso along with the implicit devaluation of the Venezuelan bolivar following the introduction of the new exchange rate mechanism (SICAD I), although this impact eased slightly in the second quarter. Thus, in the January-June period, exchange rates reduced year-on-year revenue and OIBDA growth by 10.9 percentage points (-10.0 percentage points in the second quarter, from both revenue and OIBDA).

This way, changes in the perimeter of consolidation (deconsolidation of Telefónica Czech Republic), reduced year-on-year revenue growth in the first half of 2014 by 3.1 percentage points (-3.0 percentage points in the second quarter) and year-on-year OIBDA growth by 3.7 percentage points in both the first half and the second quarter of 2014.

Despite both impacts and the Capex increase, free cash flow generation reaches 1,664 million euros, improving significantly year-on-year (+14,7%).

Revenues totalled 24,957 million euros in January-June 2014, 12.6% lower year-on-year (-11.8% in the second quarter), impacted by the abovementioned exchange rate fluctuations and changes in the consolidation perimeter. In organic terms, revenues posted positive growth for the fifth quarter in a row (+1.3% in the second quarter; +1.4% in the first half), driven by the strong growth of T. Hispanoamérica (+11.3% in April-June; +13.0% in January-June) and mobile data. Excluding the negative impact of regulation, organic revenues grew 3.6% compared with the first half of 2013 (+3.7% year-on-year in the second quarter).

Mobile data revenue growth accelerated year-on-year in organic terms for the second consecutive quarter (+9.2% in the second; +8.8% in the first; +7.8% in the fourth quarter of 2013). In the first half of 2014, these revenues grew 9.0% year-on-year in organic terms and already accounted for 40% of mobile service revenues, 3 percentage points higher than the same period of 2013. Non-SMS data revenue performance was particularly noteworthy, with year-on-year growth improving to 23.8% in organic terms in the first half (+24.1% in the quarter) and already accounting for 72% of total data revenues (+9 percentage points year-on-year).

Consolidated operating expenses totalled 17,427 million euros in the first half, 11.9% lower year-on-year (-10.8% in the quarter). In organic terms, operating expenses rose 1.6% in the first six months (+1.7% in the quarter) mainly due to higher commercial and network and systems costs.

Operating income before depreciation and amortisation (OIBDA) in the first half amounted to 8,055 million euros, 14.5% lower year-on-year impacted by the already mentioned exchange rate fluctuations and changes in the consolidation perimeter. In organic terms, OIBDA remained virtually stable compared with January-June 2013 (-0.1%). In the second quarter, OIBDA fell 0.7% year-on-year in organic terms (-15.0% reported), mainly due to the increased commercial momentum and activity focused on capturing growth opportunities. Excluding the negative impact of regulation, OIBDA grew by 1.4% compared with January-June 2013 in organic terms. OIBDA margin stood at 32.3% in the first half of 2014, with limited erosion in organic terms (-0.5 percentage points). In the second quarter the margin stood at 32.4% (-0.6 percentage points year-on-year in organic terms).

Operating income (OI) totalled 3,892 million euros in the January-June period, 7.9% higher year-on-year in organic terms. In the second quarter, OI advanced 10.4% year-on-year in organic terms to 2,055 million euros.

As a result, consolidated net income in the first half amounted to 1,903 million euros, 7.5% lower year-on-year, and basic earnings per share amounted to 0.41 euros (-11.0% year-on-year). However, in the second quarter net income increased 4.9% year-on-year to 1,210 million euros (affected in 291 million euros by the aforementioned revaluation of deferred taxes) and basic earnings per share stood at 0.26 euros (+2.0% year-on-year).

Technological transformation and network modernisation

With regards to investment, the Company continued focused on technological transformation and network modernisation, with over 71% of total investment devoted to business transformation and growth. CapEx grew 27.2% year-on-year in organic terms (-9.8% reported) in the first six months and totalled 3,523 million euros. It is important to note that CapEx included 189 million euros relating to spectrum acquisition in the first half of 2014, primarily in Colombia and Central America (834 million euros in the first half of 2013, mainly in the UK, Spain, Brazil and Uruguay).

Again, despite this Capex increase and the impact of both exchange rates and perimeter changes, free cash flow generation reaches 1,664 million euros, improving significantly year-on-year (+14,7%).

Net financial debt stood at 43,791 million euros at the end of June 2014, down 6,002 million euros year-on-year and 1,590 million euros in the last six months. However, debt rose by 1,067 million euros in the second quarter, mainly as a result of the payment of a dividend of 0.40 euros per share in May. Including post-closing events (sale of T. Ireland), debt stood at 42,961 million euros. The leverage ratio (net debt over OIBDA) for the last 12 months stood at 2.47 times at the end of June 2014, and at 2.43 times including post-closing transactions (disposal of T. Ireland).

In the first half of 2014, Telefónica's financing activity through bond and loan markets stood at around 9,880 million equivalent euros. This activity was mainly focused on strengthening the liquidity position, actively managing the cost of debt and smoothing the debt maturity profile of Telefónica S.A. for the following years. Therefore, as of the end of June, the Group maintains a comfortable liquidity position to accommodate the next debt maturities. In Hispanoamérica, Telefónica's subsidiaries tapped financing markets for approximately 151 million equivalent euros in the January-June period. Also noteworthy is the 500 million euro bond placement by T. Deutschland in January.

Digital Services and Telefonica Global Resources

The area of the CCDO (“Chief Commercial Digital Officer”) continued focused on bringing digital services at the core of our customers’ offer. The key advances during the second quarter are as follows: In the Corporate (B2B) area, M2M revenues maintained a good performance, rising more than 50% year-on-year in organic terms on the back of the growth in M2M accesses (+16% year-on-year) following several special projects secured in the first half.

Revenues from the Cloud business continued growing at double digit rate, above 20% year-on-year in organic terms in the first six months of the year. Regarding Information Security, Telefónica signed an agreement with Etisalat that will enable both companies to collaborate in the development and implementation of a SOC (Security Operation Center) in the United Arab Emirates.

In the Consumer area, the good performance of the Video business stands out, with revenue growth in the first half accelerating to above 15% in organic terms, boosted by the solid access growth (+32% organic year-on-year), and with significant progress in both Spain and Brazil (+91% and +28%, respectively). During this quarter Telefónica also acquired the exclusive rights in Spain for Euro 2016 qualifiers and 2018 World Cup. These new exclusive rights, together with those secured previously for Roland Garros, Moto GP and Formula 1, makes the Company's sport offer the most complete in the Spanish market.

Especially noteworthy in the Financial Services area was the launch of the customer loyalty community “Yaap Shopping” through the joint venture with CaixaBank and Santander.

The Global Device Management area continued to drive smartphone adoption with a special focus on LTE. Thus, 74% of total devices acquired in the second quarter were smartphones, with the total volume of LTE devices bought by the Group increasing by 8 times year-on-year.

Telefónica Global Resources continues to drive the Company's technological transformation, accelerating the rollout of ultra broadband (UBB) infrastructure, in line with the targets set for the year, ensuring better network quality and helping businesses transformation, with IT as a key enabler. In parallel, the Company continued progressing with the development of initiatives aimed at increasing efficiency.

The global Network and Operations unit advanced with the UBB rollout, reaching 10.5 million premises passed with fibre at the end of the quarter (1.9 times more than in June 2013), surpassing the 13,500 base stations with LTE (5 times more year-on-year) and with over 80% of 3G and LTE base stations connected at high speed to the transmission network.

Thus, the Company is prepared for the material data traffic growth in the network (+35% year-on-year in the second quarter), driven both by mobile broadband (+47% year-on-year) and fixed broadband traffic (+34% year-on-year).

The global IT unit, business transformation enabler, is focused on automation, standardisation, reutilisation and modernisation as common principles. In this regard, it should be highlighted the launch of business support systems in some Hispanoamerica countries as well as the development of new online capabilities (e.g. real-time contextual marketing campaign tools, portal renewals with public and restricted access, new electronic self-service channels in stores and via mobile devices, etc.).

Additionally, shared IT services were also used to progress towards doing things once, unlocking efficiencies and quality improvements benefiting from scale. Especially noteworthy is the Group-wide availability of a new KPI “Global PKI” service that allows digital certificates issuance, improving information security management on infrastructures.

Finally, further progress was achieved towards the goals set for infrastructure consolidation and applications transformation, with a 6% reduction in physical servers in the first half of 2014, eliminating more than 160 applications and at the same time, growing virtualised servers to 38%.

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