Telefonica Brasil S.A. Q2 FY2022 Earnings Call

Good morning, everyone. We would like to welcome you to the Telefonica Brasil Second Quarter of 2022 Earnings Conference Call. Joining us from the management team are Mr. Christian Gebara, CEO; Mr. David Melcon, CFO and Investor Relations Officer; and Mr. Gabriel Menezes, IR Senior Manager. We also have a simultaneous webcast with a slide presentation available at www.telefonica.com.br/ir, where you can access a replay of this call. After the remarks from the company, we will have a question-and-answer session, and further instructions will be provided at that time. Prior to proceeding, I want to note that forward-looking statements are being made in accordance with the Securities Litigation Reform Act of 1996. These statements are based on management's beliefs and assumptions, as well as available information, and they are not guarantees of future performance. They involve risks, uncertainties, and assumptions that relate to future events and depend on circumstances that may or may not occur. Investors should be aware that general economic conditions, industry factors, and other operating elements could impact the company's future results and lead to variations from the forward-looking statements. Now, I'll turn the conference over to Mr. Gabriel Menezes, Senior Manager of Investor Relations at Telefonica Brasil. Mr. Menezes, please go ahead.

Thank you very much. Good morning, everyone. And welcome to Telefonica Brasil's conference call to present the Q2 2022 results. The call will be divided as follows. To start our CEO Christian Gebara will comment on Vivo's financial and operating highlights followed by an update about our B2B and B2C digital ecosystems and ESG initiatives. Then David Melcon, our CFO will go through our costs and capital structure, net income, free cash flow, and shareholder remuneration. Now I'll hand it over to Christian.

Thank you, Gabriel. Good morning and thank you for joining our earnings call. We begin on Slide 3. In the second quarter of 2022, we incorporated assets coming from the acquisition of our share of Oi mobile. The results originated from businesses that have been considering our numbers since April 1, 2022 coupled with an outstanding quarter in organic terms, allowing us to achieve double-digit growth in key performance indicators by which we measure our business performance, access, revenues, and cash generation. Our customer base totaled 114 million accesses, as mobile postpaid reached an impressive level of 57 million lines, while FTTH connections increased by 25% year-over-year, reaching 5 million. With the remarkable acceleration of our operating figures, our total revenues grew by 11.1% year-over-year, boosted by our mobile service revenue that expanded by 15.1%. Excluding the impact of Oi's incorporation, mobile service revenue was up 9.4% in this period, considerably ahead compared to recent quarters' performance. Our EBITDA has grown by 8.3% versus the second quarter of 2021, offsetting the impacts of rising cost inflation, and driving the operating cash flow generation in the first six months of 2022 to expand 3.3% year-over-year. Moreover, aligning with our strong top-line performance and efficient financial management, our free cash flow rose by 13.9% in the first half of the year, reaching R$4.6 billion, contributing to the distribution of R$3.1 billion back to our shareholders, further enhanced by R$313 million in share buybacks. These results underscore Vivo's leading position in the Brazilian telecom landscape, recognized not only by our strong financial performance but also by the strength of our brand, which was considered the fourth most valuable in Brazil among all sectors, valued at almost $4 billion. Moving to Slide 4, you can see on the left side of the slide the continued improvement of our revenue mix. Core businesses have increased their relevance by three percentage points year-over-year, making up 2% of our top-line revenue. On the right side, we illustrate the reaffirmation in the market as our total revenues continue to show improved yearly performance quarter after quarter. It's important to note that this growth is occurring despite the more challenging macroeconomic environment, emphasizing the importance of connectivity and the resilience of our main services, such as fiber and B2B solutions. In the next slide, we will delve deeper into our core segments that are benefiting from their positive momentum, with mobile revenues expanding by 16% year-over-year and fixed core revenue increasing by 10.8%. We experienced double-digit growth in all mobile sales, a result of our superior level of service and the strategic direction we've taken, along with a healthier pricing environment. Consequently, our mobile service revenues grew by 15.1% year-over-year, marking the highest expansion we've seen in over a decade. Meanwhile, core fixed revenue continues to yield results, driven by ongoing fiber expansion and our wide range of B2B solutions that position Vivo as the sole entity in the market capable of providing enterprise customers with the best connectivity platforms, tailored services, and applications from leading global partners. Now on Slide 6, we present our superior breaking results. Our Oi mobile base grew 23% year-on-year, reaching 99.2 million accesses with the addition of approximately 12.6 million coming from Oi, on top of 1.4 million in organic postpaid accesses. It's worth mentioning that in the second quarter of 2022, we achieved our highest level of organic postpaid growth, excluding machine-to-machine additions in over seven years, with approximately 1 million new lines quarter-over-quarter across hybrid and pure postpaid. This remarkable outcome, along with the lowest level of postpaid churn in Vivo's history, reflects our unmatched quality of services and brand positioning as our customer base continues to expand month-after-month. Regarding fiber, we reached 21 million home passes in 354 cities, totaling 5 million customers. The FTTH business is our main growth lever, and we continue to expand our fiber footprint through organic deployment across Brazil. Moving on to Slide 7, we give an update on our B2B and B2C digital services. As you can see on the left-hand side of the slide, the revenues coming from the sale of digital B2B services continue to outperform, growing 36% year-over-year to reach R$2.3 billion over the last 12 months, led by high demand for cloud, cybersecurity, and digital solutions. Another promising corporate segment is Vivo Agro. Today, Vivo Agro delivers high-performance efficiency assurance services to farms. However, we see an excellent opportunity in this sector, as we develop partnerships with specialized suppliers to create a comprehensive portfolio of solutions for modern agricultural businesses. This includes launching new IoT products to provide management tools that increase the productivity of our customers’ operations. They will, for example, be able to manage and track capital remotely and use drones to monitor perimeters or apply agricultural inputs on crops. Regarding our B2C ecosystem, Vivo Money continues to expand with over R$80 million in credit considered so far after originations grew more than sixfold this quarter on a yearly basis. In the meantime, Vivo's joint venture is progressing according to plan. We have already defined the CEO and management team, heavier targets, and we expect to launch a minimum viable product by the end of 2022. Lastly, Vivo Ventures, our corporate venture capital, is in its final steps towards its first round of investments after creating a shortlist of the top 20 potential industries selected according to their growth potential aligned with Vivo's digital ecosystem strategy. On Slide 8, we present our first issuance of debentures linked to ESG goals and the recently launched financing framework. The debentures issuance helped us take another step forward toward becoming a more sustainable and diverse company as its aligned financial, environmental, and diversity objectives. The debentures remuneration is subject to two ESG-related goals: the reduction of our direct greenhouse gas emissions by 40%, and ensuring that 30% of our leadership roles are occupied by underrepresented groups by the end of 2027. Moreover, the new financing framework simplifies Vivo's approach to sustainability investments and the market in general, allowing for streamlined emission and allocation of future investments with social impact and a low carbon footprint. With that, we'll be able to continue expanding our contribution to the United Nations Sustainable Development Goals that supports our overall ESG strategy. Now David will take us through the financial highlights of the quarter.

Thank you, Christian, and good morning, everyone. On Slide 9, we detail the company's cost showing the ongoing trends of changing the mix, as we increase the share of revenues that go beyond connectivity. Recurring costs grew 12.9% year-over-year, slightly above inflation. This quarter, we had strong results in digital services, handsets, and equipment, leading to a revenue-driven cost of services sold that grew 16.3% year-over-year, representing 30% of our total mix. Meanwhile, cost of operations grew 11.5% due to higher expenses related to personnel from the annual salary adjustments, coupled with the continued increase in natural usage that drives up infrastructure costs, and an acceleration of commercial activities. Additionally, we reduced on a yearly basis for the eighth consecutive quarter the provision for bad debt. This positive outcome results from our well-developed billing strategy and superior credit scoring capabilities, as well as the increasing relevance of our services for our customers, allowing us to maintain bad debt under control. On Slide 10, you can see that Vivo once again increased its operating cash flow while we continue to expand investments through deployments of top-tier technologies such as fiber and 5G. Year-to-date, CapEx reached R$4.5 billion, up 6% compared to the previous year. In fact, this ongoing effort was directed towards building the best network, currently positioning us as the player with the largest 4.5G coverage in the country, as we already provide decent data experience to 86% of the Brazilian population. As a result, our operating cash flow, which we believe is a key metric to monitor the profitability of our operations, amounted to R$4.6 billion year-to-date, up 3.3% compared to the previous year. This enables us to achieve an operating capital margin of 20.8% over the last 12 months, maintaining the above 30% level seen in recent years. Moving now to Slide 11, the real evolution of our net income was impacted by higher debt linked to the acquisition of 5G frequencies and mobile assets, which, while improving our capital position, results in higher financial costs, especially with the recent hikes in local interest rates. Additionally, the year-over-year net income comparison is affected by non-recurring effects that impacted the results from the first half of the previous year. Regarding financial debt, we ended June 2022 with R$3.9 billion of gross debt, which includes R$1 billion of bank debt issued in April this year, as well as commitments related to the 5G licenses acquired last year, part of which we already paid for during this quarter. Nonetheless, given our solid operating results and increased financial management, we managed to generate R$4.6 billion of cash in the first six months of 2022, increasing 13.9% year-over-year and reinforcing our ability to convert standard operating performance into cash. Finally, on the left-hand side, you can see that we maintain a solid level of shareholder remuneration, supported by the execution of our share buyback program that we have accelerated. We will continue to direct resources for that, having already invested R$330 million this year, of which R$271 million was included in the current buyback program that expires in February 2023. To conclude, on July 19, we made the first payment on the 2021 paid remuneration, with a cash out of R$2.7 billion, which will be complemented by a further payment of R$3.5 billion as scheduled for October 2022.

Thank you. The floor is now open for questions. Our first question comes from Bernardo Guttman. Please proceed, Bernardo Guttman, XPI. Your microphone is open. We will now move to the next question from Andre Salles, UBS.

Hi, guys. Good morning. Thanks for taking my question. I have a question regarding margin. We saw some pressure coming from costs of goods sold and personnel expenses going above inflation. Are there any costs or expenses related to the integration of Oi clients considered in this quarter? And how should we view the margin dynamics going forward? What could drive margin recovery in this case? Thanks.

So hi, Andre, yes. The market was impacted by costs of goods sold; it’s also good to highlight what we said about the digital services. The relevance of these services is reflected in our numbers in B2B, reaching R$2.3 billion and also, as you can imagine, these services come with a lower margin. There's no CapEx in most of them. So it's a lower margin, especially as we are also increasing digital services in the B2C segment and selling a lot of entertainment-as-a-service. We are now opening up the numbers in B2C, but we are growing as well in services. To highlight here is that this service is generated in relevant volume in our results, and our absolute EBITDA is growing, now above 8%. Going forward, I think what we will see is more sales of services with varying margins. At the same time, digitalization is still playing an important role in reducing our costs. We also want to see benefits from increased digitalization in customer care and also in sales commissions. We see room to increase e-commerce to much more than our current 30% in B2B sales. So it's a combination of two things. It's important to highlight that the impact in CapEx for challenges to services does not happen because these services are built all over our connectivity infrastructure that we are really deploying. The numbers of Oi are included, of course, the margin related to Oi is significantly higher, as we are serving these customers with our existing channel, especially in the Northeast, where we inherited most of the customers and the network can support these customers. So the margin is much higher from the Oi incorporation.

That is clear, thank you.

Our next question comes from Vitor Tomita, Goldman Sachs.

Hello, good morning, everyone. Thanks for taking my questions. We have a couple of inquiries on our side. The first one is regarding M&A; there has been some M&A activity involving ISPs lately, and even a transaction between ISPs announced today. Do you see opportunities to participate in M&A in that area? And the second question is regarding Oi; we’ve seen a large number of users migrated to their new operators this quarter. Are you noticing a significant movement in the market of users recently migrated from Oi requesting portability to other operators, or changing operators in general? Was this reshuffling of Oi subscribers a relevant factor in your strong organic postpaid performance this quarter? Thank you.

Victor, I’ll address the second question first, then the first. Of course, we have seen portability going up. If you look at the share of portability in our net adds; in the second quarter of 2021, portability represented 16% of our net adds, and 31% now represents our net adds. This goes beyond portability just from Oi; it includes complete portability from all operators. However, if you look at our net adds this quarter, it was 1.4 million postpaid net adds, not considering now movement from Oi customers to our customer base. This shows that yes, it can be impacting our profitability. Nonetheless, I would emphasize that our strong commercial performance of Vivo has also reinforced our position. Our churn number was 1.1% for postpaid churn, the lowest compared to the second quarter of 2021, which was 1.3%. Comparing two years ago, it was 1.5%. I think it’s a combination of factors, but our superior value proposition is attracting more customers to our customer base. That addresses the first question. Regarding M&A, we are always attentive to market opportunities on many fronts, including fiber. We have a plan to get to 29 million homes passed by the end of 2024. We currently stand at just over 21 million. We are on track to meet the targets we have set for ourselves. Any M&A decisions in the future will depend on the overlap of networks, the quality of the networks, the quality of the companies being sold, and also how we can integrate these customers into our customer base. Buying the network is one aspect; buying the customers is another, and it can become complex. When companies are too large, the integration becomes more complex. We are here to evaluate everything, but we have a clear plan to achieve our 29 million goal.

Very clear. Thank you very much.

Our next question comes from Bernardo Guttman. Please proceed.

Hi, good morning, everyone. Thanks for taking my question. Actually, I have two questions here. The first one is about the solid growth in mobile; it seems to have been accelerated by the rationality in the segment. The market consolidations seem to have brought greater rationality to pricing. On the other hand, your guidance for synergies was conservative and did not consider revenue synergy. Is it fair to assume that this trend is in its early stages? What is your view on the potential market repair of this situation? The second question relates to the subject of tax reduction. I understand that telcos are concerned about passing all benefits to customers by reducing service costs. However, I would like to understand if the price reduction opens up room for a gradual margin recovery. Historically, the sector has struggled with price adjustments, but it seems that there is now greater room for pass-through. I would appreciate your comments on this subject. Thanks.

Bernardo, I don't believe the market has changed significantly. What we see in our mobile performance is a consequence of our strategy over the last two years. We have been keen on adapting our value proposition to the needs of customers. We've been investing in networks to provide 4G, 4.5G, and preparing ourselves for 5G. Additionally, we have focused on converging our services and adding value through digital services, which we’ve executed successfully. I think the performance highlights that we are on the right path. Of course, I think all players are looking for returns, and we can see a more rational approach across the board. This is not just a quarter-specific trend, but a movement that has been occurring over many quarters. We've also observed that with increasing inflation, we have adjusted prices relative to inflation, as we have the flexibility within our plans to accommodate this. Overall, the market is reacting to broader economic conditions. Regarding synergies, we didn’t forecast revenue synergies from the Oi operation; we maintained our projections based on OpEx and CapEx as discussed previously. We can see the potential for customer migrations and the possibility for them to spend more because we offer a broader value proposition than they used to have with Oi. We are in the process of evaluating the assets we acquired and will review how they align with our performance metrics in the coming time frame. On the subject of tax reductions, it is positive to see that telecoms are now recognized as essential services. We have consistently argued against imposing high taxes on a service that enables so many functionalities for consumers. We are complying with government regulations about tax reductions, and certain states have already approved these changes. This situation is complex, considering the varied tax reductions in different states; however, we are effectively passing on customer benefits where possible. What we believe going forward is that customers will now have the ability to purchase more services because prices may be reduced under these conditions. They will also have the capacity to retain their service plans since inflation impacts might be mitigated by tax reductions. This could overall be beneficial for consumers and us.

Very clear response. Thanks a lot.

Our next question is from an unidentified analyst from Bank of America.

Hi, good morning, everyone. And congratulations on the results. I have a question regarding ARPU. Could you provide further insight into how the ARPU performed organically, not considering Oi's contributions, for both postpaid and prepaid? Also, looking ahead to the next quarters, do you believe the fact that we are now down to only three players will also positively impact ARPU, and in addition, regarding churn, as you've mentioned, you have achieved a lower churn rate compared to before. Do you expect this to continue moving forward? Thank you.

I think going forward, yes, but we are not providing specific trends about the performance of any indicators. However, I'm optimistic about our position and believe that loyalty and lifetime value of customers with Vivo will increase. Regarding ARPU, it is impacted by Oi; they come with a lower ARPU, and as you know, this has a negative effect on our postpaid ARPU. There are two effects here on postpaid ARPU: first, lots of migration from prepaid to postpaid is impacting the mix negatively, and second, the customers integrating into our customer base are also lowering our average ARPU. We are not sharing all this detail, but if we exclude the impact of the Oi integration, our ARPU would be positive moving ahead. In both prepaid and postpaid, that's something I can share. However, this is compounded by Oi, as there is a significant and accelerating migration from prepaid to postpaid currently, which supports positive revenue evolution for both segments — prepaid growing at 18.3% and postpaid at 14.4%. If we exclude Oi, we reached a growth of 15.1%. So, if we were to carry out this calculation, ARPU would reflect positive performance excluding Oi’s metrics.

Okay, thank you.

Our next question comes from an unidentified analyst from HSBC.

Hi, thanks for taking my question. My main question is regarding working capital. It seems that this quarter has been positively impacted by a significant change in working capital of R$1.4 billion. What is driving that positive working capital, and how sustainable is it going forward? Thank you.

Thanks for the question. The positive impact in our working capital this year comes from the tax benefits we obtained last year in the second quarter, which are related to tax credits that amount to around R$2 billion. At this point, we’re benefiting from approximately R$500 million per quarter. Also, if you compare this to the working capital in the last quarter, where we had negative R$628 million, this indicates improvement over time. At the end of the day, the working capital reflects seasonality, but if we take the overall performance over the last two to three years, we see continued robust capital generation. Therefore, seasonality does not essentially impact our annual figures.

Yes, thank you.

Speakers, you may proceed. Our next question comes from an unidentified analyst from JPMorgan.

Hello, can you hear me?

Yes.

Perfect, thank you for taking my question. Could you provide some context on the dynamics we are observing in broadband? We saw a slight slowdown in your net ad pace. Is this a reflection of slower economic activity overall, or is it due to increasing competition? That's my first question. My second question is regarding margins; are we seeing the full benefit of the migration from Oi, or will this take some quarters to truly translate into improved margins? Should we expect year-on-year margin expansion in the upcoming quarters just from the effects of Oi? Thank you.

Hi, this is Christian. The broadband market as a whole is experiencing slower growth than before, possibly due to a high demand spike during the pandemic period. However, we are confident in our ability to lead this market through expanding and connecting customers while maintaining rational pricing strategies. Our company continues to penetrate this market, and we’ve reached five million customers in FTTH. Observing the market currently, there has been a natural deceleration; however, we remain committed to our plan to reach 29 million connections by the end of 2024. We are responding to customer needs while remaining aware of broader economic trends. For margins related to Oi, David can expand on that.

So addressing the second question, the Oi deal is accretive; however, the actual margins and the synergies will continue to improve quarter-over-quarter. As a reminder, for the first 12 months post-acquisition, we will need to pay R$150 million to Oi as part of the transition service agreement to service the 12.5 million customers being migrated. Once fully integrated, our costs will be lower than this. We are also investing in CapEx to support the network in regions where we are receiving Oi customers this year—this level of expenditure won't be necessary in following years. Hence, we are saying that the margin will likely be above 70% for revenues from Oi customers, and the numbers in Q2 indicate that margins will improve in the upcoming quarters.

Perfect, thank you very much.

Our next question comes from Luis Azevedo, Safra.

Good morning everyone. My first question is regarding revenues from Oi. It seems that the revenues from Oi customers are lower than the rates indicated at the time of closing the acquisition. Do you agree with that? Also, do you see potential for upside from Oi customers?

I'll take that one. When we published our information around the Oi integration, we mentioned that we projected around R$155 million in revenues per month based on the numbers from March. We began integrating Oi in April, and the revenue we are currently observing may be slightly lower than the initial estimates. However, the key point is that most of the customers we acquired were prepaid, ensuring the overall revenue impact is not dramatically different. We have seen organic migrations from Oi to our network, and our portability is accelerating; thus, we expect to see no significant negative impact on revenues going forward—potentially even upside on these migrations as we integrate and cross-sell to these customers. However, it will take time, possibly a window of 12 months.

Thank you. My second question deals with the roaming dispute. Can you provide more details about where this discussion stands?

We are currently discussing the model utilized to calculate roaming. We agree that we need to present roaming tariffs; however, our perspective is that the model should be grounded in the BGMC (General Plan for Concession Goals). We’ve made our first offer based on the existing regulations, which encompass a traditional top-down approach as well as historical cost accounting. The modeling for roaming tariffs has been debated, and we are seeking to establish a consensus moving forward.

Thank you.

Our next question comes from Andre Salles, UBS.

Hi guys, thanks for the follow-up here. Could you please comment on the assets coming from the Oi mobile acquisition and the decommissioning plan you have for those? Are you estimating costs related to the contractor lease termination?

Those assets are for sale. That was part of the obligations we agreed to. Approximately 60% will be divested to comply with regulatory obligations. We anticipate this will take about four months, and we will comply with obligations accordingly. We will await the offers on the table before moving forward with decisions. I can supplement more on that, Andre.

To complement what Christian stated, we booked liabilities on our balance sheet regarding the 2,700 sites acquired from Oi. The current provisions amounting to R$700 million stem from the decommissioning processes. A significant portion of these provisions is already reflected in our balance sheet as we move toward renegotiating terms with service providers. More than half of these sites will be decommissioned, thus creating an opportunity for us as we manage this process over the next 12 months.

Got it, just to confirm, is that related to the close to R$700 million that is booked on your balance sheet right now, or is it different liabilities?

Yes, this provision breaks down into two components, one related to IFRS 16 amounting to R$700 million, while another R$700 million is recorded under other provisions. Those liabilities correspond to sites set for sale per the remedies we are implementing. We've divided the evaluation into two strategies, with one half undergoing a divestment process and the other half following a defensive strategy. All these aspects are considered in our balance sheet.

Okay, got it. Thank you.

Our next question comes from Cesar Medina, Morgan Stanley. How do you expect the rollout of 5G to impact your CapEx trends considering density CapEx versus revenues? Christian?

The rollout of 5G is part of the natural evolution of technology, and we continue to invest in these new technologies. Our expenditures for 4.5G were made to develop broader coverage. We have started implementing 5G in cities defined under regulatory obligations, with potential to extend coverage further as we see speed benefit. The rollouts represent an ongoing investment, but it's balanced against discontinuing investments in outdated technologies such as 2G. We continue to position ourselves as the leading infrastructure provider for both mobile and fiber in Brazil while expecting additional revenues as we differentiate ourselves through our value proposition for connectivity and digital services. This ongoing shift will feature a blend of investments in new technologies while curtailing those in older networks.

Thank you. This concludes the question-and-answer session. At this time, I would like to invite Mr. Christian Gebara for any closing remarks.

Thank you all for attending our call. As I mentioned at the outset, we are extremely satisfied with the robust results we've presented, particularly emphasizing the unique growth we've seen in all revenue lines, achieving double-digit results along with increases in EBITDA and free cash flow, demonstrating our strong performance. We remain open for any further questions from the team, and again, thank you all for participating.

Thank you. This concludes today's Telefonica Brasil's second quarter 2022 results conference call. You may disconnect your lines. Have a nice day.