Earnings Call Transcript - TIMB Q3 2022

Operator, Operator

Good morning, ladies and gentlemen. Welcome to TIM S.A. 2022 Third Quarter Results Conference Call. We would like to inform you that this event is being recorded and all participants will be in a listen-only mode during the company’s presentation. There will be a replay for this call on the company's website. We highlight that statements that may be made regarding the prospects, projections and goals of TIM S.A. constitute the beliefs and assumptions of the company's board of executive officers. Future considerations are not performance warranties. They involve risks, uncertainties and assumptions as they refer to events that may or may not occur. Investors should understand that internal and external factors to TIM S.A. may affect their performance and lead to different results than those planned. Now, I will turn the conference over to the CEO, Mr. Alberto Griselli, CEO of TIM S.A.; and to Ms. Camille Faria, Chief Financial Officer and Investor Relations Officer, to present the main messages for the third quarter of 2022. Please Mr. Alberto, you may proceed.

Alberto Mario Griselli, CEO

Good morning, everyone, and thanks for attending our results conference call. I'm pleased to say we had another great quarter. We are presenting strong numbers in all lines. We are growing solidly and maintaining our high level of profitability while delivering all the transformational initiatives we planned for 2022. TIM is now a bigger and better company. Also, the next generation TIM path is just beginning. We move with great strides towards our goals. In the third quarter, our top line grew more than 24% year-over-year. Our EBITDA also presented great momentum, accelerating to nearly 25% yearly growth, which led our margin to exceed 48%. For year-to-date figures, EBITDA minus CapEx rose 25%, with a cash flow margin above 25%. Until September, we announced close to BRL 1 billion in interest of capital, and we are very comfortable fulfilling our remuneration guidance of BRL 2 billion. Strategic initiatives are advancing according to plans. On 5G, our smart rollout approach is giving us leadership in coverage where it matters the most to TIM. Our integration process is evolving rapidly and we are already benefiting from it in multiple forms. Essential phases of the integration have already been completed. DSG front presented other relevant accomplishments in the third quarter and recognition of TIM Brazil as the world's most diverse and inclusive telecom operator. TIM as an employer was awarded as a great place to work, while our clients also gave us great ratings on the Reclame Aqui portal for excellence in customer service. Additionally, we're using the power of technology to help develop communities under a partnership with the NGO, Geraldo Falcoes. So when we say ESG is embedded in our strategy and everyday action, it isn't just a claim. Getting into additional detail in our revenue dynamics, we saw mobile service revenues grow close to 26% year-over-year, while fixed service was up by more than 8%, consolidating our service revenues at an expansion of 25% year-over-year. Once again, it is essential to highlight that this revenue performance was driven by more than just the Oi assets acquisition. Our organic performance continues to be helped by the positive net effect of price ups, a benign macro environment, and rational competition. Postpaid revenues continued with its solid expansion, up almost 26% year-over-year with an ARPU of BRL 36 per client per month. Prepaid revenues rose more than 30% versus last year, pointing to an ARPU of close to BRL 13. As expected, the average revenue per subscriber is being diluted by the acquired customer base with a lower ticket in both segments. With this, mobile blended ARPU stood at BRL 24.9. These metrics will show some importance of volatility as we haven't started to clean up the acquired base. We expect to begin in November and the process should take months to complete. Although much of our attention is focused on the integration process, we continue to innovate, as this is a fundamental part of our positioning as a company. During the quarter, TIM launched a partnership with LATAM and Gol Airlines to offer in-flight connectivity embedded in our postpaid TIM Black plans. We also expanded our partnership with Amazon to provide content for prepaid and postpaid customers. TIM Mobile and as I mentioned earlier, the 5G launch is a success. The smart coverage approach and an assertive device strategy are delivering competitive differentiation and customer experience improvements. Our 5G coverage arrived in all state capitals with a particular focus on crucial markets like Curitiba, Sao Paulo, and Rio de Janeiro. Today, we have more than our peers' combined number of antennas giving TIM an edge over competitors. When we sum this up with the acceleration of 5G device penetration driven by TIM and big retailers, we already see 10% of traffic offload in major state capitals. The importance of this accelerated adoption comes from the potential savings in 4G CapEx and in better customer experience. It is early, but in the first measurements, 5G users have twice the NPS of customers using the older technology. Let's now move and go deeper into the integration of Oi assets. As I mentioned earlier, integration is on track with network implementation proceeding at a solid pace while client migration is starting to accelerate. On the network, the first two phases, roaming and frequency availability, were completed while full integration should be achieved in early 2023. The migration of the acquired base to our system is occurring in waves to ensure we do it properly and with minimum impact on clients. Until September, we migrated 2.5 million customers. Due to the complexity of the process, we should take the entire 12 months we plan to complete the entire process. On a separate initiative, the commissioning process is starting this month following a necessary system implementation that allowed us to consolidate ERP functions for the acquired assets. We plan to decommission 400 sites in 2 months. In 2023, an additional 3,000 sites will be shut down, leaving approximately 1,300 until December 2024. Lastly, on the M&A topic, as you probably saw in our communications during the quarter, we together with the other two buyers entered into a litigation process with Oi related to adjustments to the closing price and indemnities. The total amount under discussion is BRL 3.2 billion. The situation is developing on two fronts. One in legal courts, where the judicial recovery judge determined the buyers to deposit the withheld amount of BRL 1.5 billion in an escrow account, which has been done a couple of weeks ago. The other in the arbitration court of B3, the buyers initiated this path. The following topic is an update on B2B. As we discussed during our Investor Day in May, we are focusing on selected verticals to offer a complete set of connectivity, IoT and tech solutions to Brazil's industry leaders. Three of these verticals are already showing promising opportunities. In agribusiness, the vertical we have been working in for longer, we offer solutions to increase productivity, covering millions of hectares of crops and fields, doubling our coverage in the last 12 months. We started with solutions based on 4G technology, but we already closed a few deals to develop 5G with groups like Sao Martinho. In logistics, we can positively impact lead times and fleet management, taking transportation efficiency to the next level. Again, we almost doubled the number of kilometers connected with IoT projects, and we are starting a 5G initiative with BTP in Santos port, the largest in Brazil. With the utility sector, we can collaborate for smart lighting solutions, improving distribution and increasing automation. Over the last quarter, we increased the number of public smart lighting points ninefold with NG being one of the major partners in such initiatives. Changing gears to fixed service, TIM Live had another solid quarter amid its transition to a new operational model using I-Systems as its network growth platform. We grew revenues at around 12%, taking third quarter revenues to more than BRL 200 million. Fiber users represent more than 70% of the entire base and the FTTC to FTTH migration is helping churn to reduce materially. Voluntary churn declined by 1.5 pp since the first quarter. As a result of our efforts to grow sustainably with a high-value service and portfolio, we maintain a strong FTTH ARPU level of close to BRL 98 despite competitive pressure. We resumed our footprint expansion in the first half, and in October, we added a new regional class of centering Campinas, an important city in the countryside of Sao Paulo state. Now I will pass the floor to Camille, our CFO, to review the financial results.

Camille Loyo Faria, CFO

Thank you, Alberto, and good morning, everyone. As Alberto explained earlier, the third quarter was marked by improvements in all lines of our results. Our OpEx, although still pressured by the same elements we saw in the previous quarter, presented a deceleration when compared to the second quarter, 24% versus 25% year-over-year. This trend reflects a larger company following the M&A transaction, but all cost lines remain under control. With revenues growing faster than in the second quarter and OpEx expanding slower, EBITDA dynamics accelerated. EBITDA for the quarter increased by 24.5% versus third quarter 2021 with a stable margin of 48%. Net of the I-Systems costs, we would have had more than 28% of EBITDA growth with a margin of 49.5%. Of course, this record-high EBITDA was driven by service revenue growth from organic performance and M&A amid an environment of cost under pressure and carrying a lot of transitory effects. Looking ahead, it's always important to remember that we are carrying the burden of the temporary service agreement with Oi that will end in April of next year. We expect a much cleaner OpEx dynamic in 2023 as both impacts from the TSA and I-Systems will start to disappear. Last quarter, some of you became a bit worried about our bottom line dynamic. And as we explained, there were many transitory and temporary effects. In the third quarter, some of these impacts already started to ease, but some will remain until we finish the asset integration and site decommissioning. Site leases continue to impact D&A and financial results significantly. And despite starting the decommissioning in the fourth quarter, we will only benefit from it later in 2023 and 2024. As a result, net income came in line with the third quarter of 2021 at BRL 473 million. And we feel very comfortable to fulfill our BRL 2 billion guidance of shareholder remuneration. Until December, we will announce a portion of the remaining BRL 1 billion in interest on capital and the rest will be proposed as a dividend. If the I-Systems deal negatively impacts our costs, it benefits us even more on the CapEx side, positively affecting free cash flow. The saved CapEx is compensating for a good portion of our 5G rollout. Year-to-date, EBITDA minus CapEx is growing close to 25% and the free cash flow margin is exceeding 25%. Our cash position remains solid even after the payment for Oi assets. We closed the quarter with approximately BRL 3.7 billion in cash. So even after the court decision to transfer BRL 700 million to the escrow account, we will retain more than BRL 3 billion. This deposit will not impact our leverage guidance since we took into consideration the total payment to Oi. Additionally, our indebtedness level is comfortable. In the third quarter, the net debt-to-EBITDA ratio remained below 1.5x. Now I hand the call back to Alberto to complete the discussion related to the third quarter.

Alberto Mario Griselli, CEO

Thank you, Camille. It is fair to say we are executing firmly the plan we set ourselves to deliver in 2022. Despite a very tough and uncertain year, we expect to meet our financial and ESG targets. Our accomplishments in this first 9 months confirmed our progress to build the next-generation team, evolving step-by-step to become the best mobile operator in Brazil. Building this new chapter in TIM's history takes immense effort. So I'd like to thank the entire team for their outstanding work and commitment. Additionally, we have a new executive team member. Fabiane Reschke joined TIM Brazil as the new Legal Officer. She has a vast experience both in telco and other industries. So I'd like to give her a warm welcome and wish all the luck and success. It is great to have her on board. Now let's open the floor for questions. Please operator.

Operator, Operator

Our first question comes from Marcelo Santos with JPMorgan.

Marcelo Santos, Analyst

The first question is the ICMS impact. I wanted to understand better, especially on prepaid, where they decided to increase the allowances and not change prices. Did this impact already happen? And how much of the quarter was impacted by ICMS? And the second question would be about the litigation with Oi. How did this impact the P&L and the balance sheet if in any way? Could you just describe how each part moved because of this, for example, deposit in the escrow account? Did this impact earnings or taxes or anything?

Alberto Mario Griselli, CEO

Marcelo, let me start with the first question, and then I will hand over to Camille for the second one. When it comes to prepaid, we already implemented the measures for gross additions and the customer base. Roughly it was in August. And basically, we followed, as already commented on many occasions, with larger gigabyte benefits for our customer base. So when you look at the combined effect, what you see already in the quarter is a positive impact of the ICMS reduction on the net revenues, but at the same time, there is a reduction of sort of cannibalization in recharges, then thereafter translating revenues because we have a big chunk of our customers that recharge more than once. And so basically, the additional gigabytes or megabytes that we're giving to the clients cannibalize their recharges. So what you see in the quarter is the net effect of the better net income due to ICMS and the cannibalization of recharges due to the extra gigabytes that we are offering to the entire customer base starting in August.

Camille Loyo Faria, CFO

It's working, okay. Marcelo, regarding your Oi question, right now, we had no impact yet from the BRL 700 million deposit that we did. That's our part that we did on the escrow account. On the P&L, with the conservative approach we took, we left the transaction as initially recorded in our numbers. With respect to the balance sheet, you will not see that in September, of course, because the deposit was made in October. But as of October, we'll have roughly BRL 700 million of cash moving from our cash position to a judicial deposit. But as I mentioned in my speech, that will not impact our leverage guidance for the end of the year because when we developed the guidance, we were already counting on the fact that we would have to pay the full price for Oi that was before the price adjustment request.

Operator, Operator

The next question comes from Diego Aragao with Goodman Sachs.

Diego Aragão, Analyst

A quick one from my side, I just want to get an updated view about your CapEx outlook and whether we should start thinking about potential changes going forward. I mean if we will think about the first, with mobile integration process; secondly, initial results in 5G and then the asset-light model with this partnership with I-Systems, are you seeing any major efficiencies at this point that could eventually lead to a downward revision of your annual guidance? So this is the first question. And my second question is related to the B2B business. If possible, can you just help us to understand the economics of these projects you are presenting? If you can illustrate, for example, who is responsible for the related CapEx for network maintenance costs? How TIM gets paid in these types of projects? And lastly, what kind of margin you should achieve and the average level of return you were looking for? That would be great.

Alberto Mario Griselli, CEO

Thank you, Diego. Those are two extensive questions to address during the call, but let's tackle the first one since it's simpler. For our capital expenditures in the third quarter, we came in just under BRL 1 billion, but we anticipate making up for that in the final quarter to align with our market guidance for the year. There will be an acceleration in the last quarter. Looking ahead to next year, what we are seeing aligns with our presentations during Investor Day. We initially expected 5G adoption to mirror that of 4G based on previous years. However, 5G adoption is happening at a faster pace compared to 4G, which positively impacts our capital expenditures for next year. We have two main catalysts for improved CapEx efficiency: the acquisition of Oi's frequencies and towers, and the 4G offload due to 5G. With the 4G offload progressing quicker than anticipated, we will be able to realize the upside in 2023 and 2024, as investments that we thought were necessary for 4G are no longer needed. We projected an upside of BRL 600 million during Investor Day, which we see materializing in the coming years. We are currently finalizing our industrial plan for 2023, 2024, and 2025, and the expected benefits are aligning with our 5G rollout. Regarding I-Systems, we are introducing a new operating expense line, which results in CapEx savings. Everything is on track with our plans. For the second question, we can further discuss this in one-on-one meetings later. There are two primary business models for our B2B operations. The first, which represents 99% of our current projects, involves providing technical services, connectivity, and network maintenance to our clients. They pay for these services, and we add a margin on top. In this model, clients cover the CapEx, and telecom services built on that network yield higher margins for us. The second model slightly differs, particularly in the utility sector we just entered, where we discuss a service model with our customers. However, the majority of our projects still follow the original model, where the client pays for CapEx, we earn a margin, and additional services on top of that bring in high margins that enhance our EBITDA.

Operator, Operator

The next question comes from Leonardo Olmos with Banco UBS.

Leonardo Olmos, Analyst

I guess two questions. The first one, just a quick recap on the decommission of the sites. You mentioned that you expect 400 sites in the remaining 2022, 3,000 sites in '23 and 1,300 in '24. I'm not sure I heard that for right. So just to recap that and if you could tell what is the impact of fines that you expect from this decommission process? That's the first question. I may ask the second after this.

Alberto Mario Griselli, CEO

Yes, so the decommission is in the three steps that you just mentioned. So you understood correctly what we said throughout the presentation. The 400 is not that we are expecting to do it; we're already doing it. So of this 400, last week, we were sort of 150 already implemented. So we are putting together the machine to make this happen this year and next year. There is a specific organizational group within the organization that is in charge of this. The plan is ready and is being executed. So you understood correctly. It's a small piece this year, as we speak already, and in November, a big chunk next year and the remaining part in 2024. When it comes to the impact of the fines, the impact of the fines is already included in our numbers. I will hand it over to Camille to give you the details about the numbers that are part of our balance sheet.

Camille Loyo Faria, CFO

Thank you, Alberto. Leonardo, there are three effects here. So the total amount of the expected fines was already included in our IFRS 16 debt as of the second quarter. So it's roughly between BRL 600 million and BRL 700 million, and it's there already. In terms of cash, of course, it will be paid when we decommission the sites. But in terms of our P&L, because it's part of our decommissioning plan, it's being amortized over time. So in the P&L, you already see the effect of the fines. It's a linear amortization over the period after decommissioning.

Leonardo Olmos, Analyst

Very good. And my second question regarding Oi's client, can you please discuss the bad debt dynamics and if you plan to disconnect these clients eventually as a competitor did?

Alberto Mario Griselli, CEO

Yes, so Leonardo, let's say the bad debt dynamics are basically the normal bad debt dynamics of mobile operators. So we got bad debt on their side. The delinquency rates on our clients is a bit higher than ours. It's business as usual, let's put it this way. When it comes to disconnection, we are planning to disconnect a material number of customers that are inactive. So they do not generate traffic. So they are not using the service. What is going to happen is that starting from November and in the next quarter, we will initiate the process of cleaning up this customer base. Basically, this is a cost avoidance opportunity on our side. There are people and customers not using the service, but we've got some costs attached to it, like taxes, license costs, etc. So we are going to initiate the cleanup this month and carry it out according to the time schedule this quarter and next one.

Operator, Operator

The next question comes from Marco Nardini with XP Investments.

Marco Nardini, Analyst

I actually have two on my side, if I may. The first one is regarding 5G FWA. I would like to know when the company intends to launch FWA plans and when we will start to see its impact on TIM's revenue. And the second one is regarding company strategy on FTTH. The current company focus is capturing synergies with Oi and also 5G rollout. However, I would like to know if you could give us a little bit view on when could we expect major FTTH expansion, please?

Alberto Mario Griselli, CEO

We have been exploring the technology for Fixed Wireless Access (FWA) in 4G and launched three pilots in 5G last year, which we discussed during our Investor Day. Our perspective on this remains unchanged. We see it as an opportunity to utilize the available capacity of 5G, although there are some hurdles to overcome in the consumer market, primarily related to solid 5G coverage in major cities like Rio de Janeiro, Sao Paulo, and Curitiba. There is also a cost issue, as the consumer premises equipment is still relatively expensive. However, we believe that the market for consumer premises equipment will grow significantly in the coming years, and we anticipate that affordability may improve by the end of 2023 or into 2024. We plan to target the consumer segment at that time if the market size and economies of scale make it feasible. The situation is somewhat different for corporate clients, where we already utilize FWA as a backup solution for key accounts, particularly in sectors like financial services. While this is a developing opportunity, we do not expect it to have a significant impact on our short-term revenues. Regarding Fiber to the Home (FTTH), our expansion plans align with what we previously outlined at our Investor Day. We have a partnership with I-Systems to deploy the FTTH network, and we are growing our customer base and revenues accordingly. This year, we launched two new clusters, one in Joinville and another in Campinas, and we are maintaining our growth strategy. We are focusing on a pace of growth that balances both volume and value in a competitive market, where we currently hold a 2% market share and have the highest average revenue per user (ARPU) in the sector. Essentially, we are managing the trade-off between growth speed and the value derived from that growth.

Operator, Operator

The next question comes from Luca Branding with Bank of America.

Unidentified Analyst, Analyst

So two questions from my side. First of all, if you could comment on what we should expect from depreciation in the coming quarters, depreciation and amortization. It increased this quarter with the full three months of acquisition. So if you could comment what we can expect? And then second, in terms of the ARPU for the Oi clients, I know it's probably difficult to say what is exactly from Oi or not right now, but are you already working on up-selling those clients? Are you having any success on that? And what's the outlook for this?

Alberto Mario Griselli, CEO

Let me address the second question about the ARPU of Oi customers. As anticipated, the average ARPU is lower in both segments, primarily due to a higher concentration of prepaid customers. This shift has contributed to the year-on-year decline in our ARPU metrics. Quarter-over-quarter, the decrease is largely influenced by the timing of our reporting, with two months accounted for this year and two months for next year. Our main focus right now is on ensuring a smooth transition for customers from Oi to our TIM system. This is a complex and sizable undertaking involving approximately 70 million customers, minus those who disconnect. We are concentrating on migrating customers from their current Oi plans to comparable or improved plans at TIM Brazil. Once we achieve this migration, we will then turn our attention to monetization opportunities.

Camille Loyo Faria, CFO

With respect to depreciation and amortization going forward, we're not giving exact guidance on that number. But just to give you a view of what's going to happen, we are still carrying the burden of 7,200 towers that we got from Oi, the contracts of 7,200 towers. As we mentioned earlier, we are going to commission roughly 400 towers this year only. As you remember, we are required by CAG to try to sell 50% of our antennas and we can't really decommission the towers while the sale process is ongoing. It started in July as we publicly announced. So we can only start massively decommissioning towers in 2023. We'll still feel the burden of those additional towers for the remainder of 2022 and part of 2023. As we start to decommission the towers, then that burden is going to ease over time. The process is expected to end by 2024. We won't really see a normalized rate in our D&A until 2025, but of course, easing over time as we decommission the towers.

Operator, Operator

The next question comes from Daniel Federle with Credit Suisse.

Daniel Federle, Analyst

The first one on the good EBITDA margin increase quarter-over-quarter. I would like to understand if part of that is coming from synergies from Oi assets and if those synergies are coming higher or faster than initially expected by the management? And the second question is more like a quick follow-up on the ICMS topic. We are seeing the financials that the company is provisioning, a portion of the ICMS that I understand to be like related to the timing mismatch between the reduction in the ICMS tax and the reduction in the billing. But it was not totally clear if these provisions are being deducted from revenues or if those provisionings are like an increase in costs.

Alberto Mario Griselli, CEO

So Daniel, I'll address the first question regarding the EBITDA margin. We are actively reviewing all cost base items, which supports the margin expansion. Regarding the Oi contribution, the situation is straightforward. In the second quarter, we received our expectations, and we began working on that. For example, concerning energy costs, we assessed the energy costs for all base stations. Once we had that information, we started to eliminate energy expenses for the BTS that we plan to decommission. This indicates that the second quarter represented the early stages of this process. We are progressing as anticipated, maintaining our pace without being slower or faster. We are diligently ensuring that the contribution margin from Oi meets our expectations. There are several opportunities we plan to exploit, such as potential future tax benefits from the Sallen base. We are also continuously managing our own cost structure to drive critical margin expansion aligned with our guidelines and commitments. Now, I will hand it over to Camille to discuss the BRL 100 million.

Camille Loyo Faria, CFO

So regarding ICMS, your statement is correct. That provision is a result of the time mismatch between the moment in which we started to collect ICMS at a lower rate and the moment in which we reflected that reduction in the clients' bills. It is a deduction of our revenues, both gross and net revenues, of course. So it's an impact on revenues; our revenues do not reflect that additional ICMS.

Operator, Operator

Without any more questions from analysts, I would like to return the word to Alberto Griselli for his final remarks. Please, Mr. Alberto, you may proceed.

Alberto Mario Griselli, CEO

Thank you, everybody, for attending our conference call. We have been very pleased to discuss with you the advance on our plans and our commitment to execute the value generation opportunities that we've been discussing this year. I want to thank, once again, the entire team for the huge effort that is being put in place over a huge number of initiatives that are running in parallel to transform TIM into the next-generation teams. Thanks to everybody.

Operator, Operator

As we conclude the third quarter of 2022 conference call of TIM S.A., for further information and details of the company, please access our website tim.com.br/ir. You may disconnect from now on. Thank you once again, and have a nice day.