Earnings Call Transcript - VIV Q3 2022

Operator, Operator

Good morning, ladies and gentlemen. Welcome to Vivo's Third Quarter 2022 Earnings Call. This conference is being recorded and the replay will be available at the company's website. The presentation will also be available for download. This call is also available in Portuguese. To access, you can press the Globe icon on the lower right side of your Zoom screen and then choose to enter the Portuguese room. After that, select mutual regional audio for a better experience. We would like to inform you that all attendees will only be listening to the conference during the presentation, and then we will start the question-and-answer section where further instructions will be provided. Before proceeding, we would like to clarify that any statements that may be made during this conference call regarding the company's business prospects, operational and financial projections and goals are the beliefs and assumptions of Vivo's Equity Board and the current information available to the company. These statements may involve risks and uncertainties as they relate to future events and therefore depend on circumstances that may or may not occur. Investors should be aware of events related to the macroeconomic scenario, the industry, and other factors that could cause results to differ materially from those expressed in the respective forward-looking statements. Present at this conference, we have Mr. Christian Gebara, CEO of the company; Mr. David Melcon, CFO and Investor Relations Officer; and Mr. Joao Pedro Carneiro, IR Director. Now, I will turn the conference over to Mr. Joao Pedro Carneiro, Investor Relations Director of Vivo. Please, Mr. Carneiro, you may begin your conference.

Joao Pedro Carneiro, Investor Relations Director

Good morning, everyone and welcome to Telefonica Brasil's conference call to present the third quarter 2022 results. The call will start with our CEO, Christian Gebara, commenting on Vivo's operating and financial highlights, followed by an update on the progress of our digital ecosystems and ESG initiatives. Then our CFO, David Melcon, will go through our cost and CapEx evolution, net income, shareholder remuneration and free cash flow. I'll now hand it over to Chris.

Christian Gebara, CEO

Thank you, Joao. Good morning and thank you for joining our earnings call. We will start on Slide 3 with the highlights of the third quarter of 2022. In the period, we were able to reach double-digit growth rates in access, revenues, and EBITDA, leading to an overall improvement of our business profitability. Our total access grew 14.6% year-over-year to 112 million subscribers, of which 57.5 million users are in postpaid and 5.3 million in FTTH, contributing for total revenues to increase 10.6% in the quarter as mobile and fixed expanded to the tune of 14.7% and 2.1%, respectively. Our strong operating momentum and capital efficiency initiatives helped our cost of operations to grow below inflation, leading to an EBITDA expansion of 12.3% year-over-year with a margin of 40.6%. The result drove improved bottom line performance as net income reached BRL1.4 billion in the quarter, up 9.3% year-over-year. In line with the enhanced profitability and robustness of our business model, which can be attested by the BRL6.5 billion in the free cash flow generated over the first nine months of 2022. We already deliberated distribution of BRL3.4 billion in dividends and interest on capital complemented by almost BRL500 million invested in the buyback of our shares. We remain fully committed to maintaining a healthy level of shareholder remuneration while also striving to create value and improve returns by investing to further differentiate Vivo's assets and value proposition. Moving ahead to Slide 4. Our revenues grew well above inflation in the quarter, expanding double digits for the second quarter in a row. This performance is being driven by the service we label as Core that already represents 92% of our top line and grew 13.8% year-over-year as we reduced our exposure to non-Core legacy operations and increased the weight of revenues coming from services that have been proving to be essential with a greater lifetime value. The resilience of our business model can only improve. On Slide 5, you can see the detailed results of our main services. On the mobile side, service revenue grew 13.8% year-over-year with strong displays from growth of postpaid and prepaid that reached a growth rate of 12% and 21.5%, respectively. We are seeing early signs of benefits coming from mobile consolidation in the form of improved user quality and experience that turns into higher consumption and market rationality. Moving to the fixed side of our core business, revenue expanded 11.2% year-over-year, again, driven by the FTTH and corporate data and ICT, both of which have been spearheading the transformation of our total fixed business. To further enhance our corporate data and ICT presence, this month, we concluded the acquisition of Vita IT, now called Vivo Vita, for up to BRL120 million. Vivo Vita already generates over BRL100 million of annual revenues and it will allow us to increase our capability in network management and recruitment solutions. Moving to Slide 6. Once again, we are pleased to present very solid operating results on mobile and fiber that are a direct consequence of our competitive advantage of being the only player capable of providing connectivity service over the best technologies available in both segments. Our mobile base expanded 18% year-over-year, reaching 97.3 million subscribers. Quarter-over-quarter, we saw a reduction of 1.9 million lines because of 3 million accesses coming from Oi that were disconnected in September as they were considered inactive according to our criteria. Excluding the effect of this clean-up, we were able to further improve the already very strong level of human postpaid net debt posted in the second quarter of 2022. Profitability remains on the rise while we keep migrating prepaid customers to our hybrid offers and maintaining healthy churn rates. On fiber, during the quarter, we expanded our FTTH network to 1.2 million new premises, reaching 22.3 million homes passed. Our accelerated footprint expansion, coupled with the fully converted Vivo Total offer that already accounts for 40% of our gross-adds, led our FTTH customer base to expand 22.1% year-over-year to 5.3 million accesses. Moreover, we recently launched our 1-gigabyte speed offer that will keep further differentiating Vivo from our broadband providers and increase the average speed of our customer base. On Slide 7, we update you on the evolution of our digital services initiatives, starting with B2B. A year ago, in the third quarter of 2021, we disclosed for the first time the amount of revenues coming from digital B2B products, such as cloud, cybersecurity, IoT, and digital solutions which back then totaled BRL1.9 billion. A year later, the same pool of revenues grew 33% to BRL2.5 billion, already representing 5.3% of our top line. These outstanding results are the product of our broad portfolio of solutions that allow companies of all sizes to digitalize their operations. On the B2C side, we highlight our Vivo Money product that evolved at a more accelerated pace. In September, we reached BRL160 million of credit considered since its inception, almost doubling in size quarter-over-quarter. We have very ambitious plans for financial services and we continue to expand our portfolio and volume. Moreover, Vivo Ventures, our corporate venture capital fund, made its first movement during the quarter, committing to invest $3 million in Klavi, a fintech focused on providing open finance solutions. Going to Slide 8. We are pleased to announce Vivo was ranked by S&P Global as one of the top 10 most sustainable Telcos in the world according to the Global Sustainability Corporate Assessment evaluation after increasing our score versus last year. Now moving to recent developments. On the environmental front, we now expect to have 85 green power plants in operation during next year, of which 42 are already functional, extending our commitment to use renewable energy in our operations. Moving to the social front as part of our effort to reflect Brazil's diversity in our workforce, we launched a Vivo training program in which 50% of roles will be filled by black people. In governance, yesterday, we announced the inclusion of Vivo's share as part of our executive variable compensation, further strengthening management's alignment with our shareholders. ESG is a core pillar of our strategy, and we continue to work very hard to improve and increase the number of initiatives taken to build a more sustainable business model. Now, David will take us through the financial highlights of the quarter.

David Melcon, CFO

Thank you, Christian, and good morning, everyone. On Slide 9, we detail the evolution of our cost base on an annual basis as we continue to transform our revenue mix, speeding up the top line growth to the sale of digital solutions and equipment that are heavier in terms of costs but much lighter in terms of CapEx. The analysis of our OpEx performance split between cost of service and cost of operations becomes even more important. We start with a revenue-driven cost of services and goods, which represents 32% of our total OpEx in the period and grew 26.9% year-over-year. This increase is mainly in line with the annual growth of our revenues coming from B2B digital services and handset sales, which were up 33% and 26% year-over-year, respectively. Therefore, as we scale up the proportion of revenues coming from these segments with benefits to customer retention and increase lifetime value, costs should respond to a similar trend. Now we move to our cost of operations that grew only 2.6% year-over-year, considerably below the last 12 months inflation that reached 7.2% in September. Here, we continue to be very effective in terms of capturing efficiencies related to the way we serve our customers by moving interactions to digital platforms which are user-friendly and far less expensive than processes involving human interactions. In addition, in the third quarter this year, we reached our lowest level ever of bad debt over gross revenues, which is also dropping 18% year-over-year. This result is a clear sign of how relevant our services are to our customers. Now, moving to Slide 10. Year-to-date, we invested over BRL7 billion in an operation, accelerating the deployment of capital in technologies that will allow us to create further differentiation versus our competitors. Our recent operating performance shows that this strategy is bearing fruit as Vivo continues to extend its leadership in higher value segments. Even though we are investing more to guarantee Vivo's present and future commanding position in Brazil, we continue to see our operating cash flow margin trending above 20% of revenues, a level we see as sustainable going forward. Moving to Slide 11. In the third quarter this year, our net income grew 9.3% year-over-year, reaching BRL1.4 billion. This positive evolution which was backed by a solid operating and financial performance in the period, creates a space for Vivo to continue directing a relevant amount of resources toward the remuneration of our shareholders. In the first nine months, we have already declared the distribution of BRL3.4 billion as dividends and interest on capital. On top of that, so far this year, we invested almost BRL500 million to buy back our shares in a movement that enhanced dividend per share. Moreover, on October 18, we paid out BRL3.5 billion related to the second tranche of the dividend and interest on capital delivered to distribute 2021 results, totaling BRL6.2 billion returned to shareholders during 2022. Finally, on Slide 12, you can see that year-to-date, we generated BRL6.5 billion of free cash flow. Considering the last 12 months' figure, we closed the quarter with a free cash flow yield of 10.6%, being able to convert BRL1,000 of net revenues into BRL154 of free cash flow. We continue to be a strong cash-generating company that helps us to maintain a healthy balance sheet, allowing us to explore investment alternatives, both organic and inorganic, while maintaining an attractive shareholder return while also providing for a space to optimize our capital structure. Thank you. And now we can move to the Q&A.

Operator, Operator

Thank you. Our first question comes from Bernardo Guttmann from XPA. Please go ahead, Mr. Guttmann; your microphone is open.

Bernardo Guttmann, Analyst

Hi, good morning, everyone. Thanks for taking my question here. Actually, I have two questions. The first one relates to 5G. The migration of data traffic to 5G networks seems to be faster than expected. If this trend remains in place, can we expect any CapEx or OpEx avoidance? I don't know if it would be easy to isolate these elements since there are other movements that should drive efficiencies, such as the additional spectrum from? And the second question, so if you could make a general comment on the mobile competitive environment, how are things trending in both segments, postpaid and prepaid? Is the competitive landscape easing now that Oi is no longer here? Thanks.

Christian Gebara, CEO

This is Christian. I'll address both questions. In 5G, we have rolled out service in all capitals and approximately 500 neighborhoods, with about 1,500 sites currently active. Among our postpaid customer base, roughly 8% to 10% of users now own a 5G smartphone. Despite the fact that most 5G smartphones sold in our stores, the overall adoption of this technology among users remains limited. Those who do have a 5G device are using more data—between 40% and 50% more—and we anticipate that usage will grow as the technology continues to improve. As we expand our 5G footprint and make devices more accessible, we're still in the early stages, so we don't foresee major changes in our deployment plans. Furthermore, our 5G rollout is actually substituting some investments we would have needed to make for 4G. In Brazil, 4G remains widely used and will continue to be for the foreseeable future. We are well-positioned in terms of spectrum, having acquired significant amounts in the auction, particularly in the 3.5 bands for 5G and additional spectrum that enhances customer experience. The spectrum acquired from Oi is also beneficial, and we plan to shift the usage of 2G and 3G spectrum to support 4G and 5G as needed. Overall, we are executing according to plan and are confident in our resources and spectrum to meet demand. Regarding the second question, the mobile market has been competitive, even with Oi in the picture, as their position was quite weak in recent years, lacking 700 megahertz for 4G. The competition among the remaining players has been intense. However, there are opportunities for a more rational market now following a tax reduction that allows us to offer more services to our customers. We believe there's potential to provide more data at competitive prices for prepaid customers, and we've seen positive revenue growth in both prepaid and postpaid segments. Given all the necessary investments and previous acquisitions for 5G, we expect the market to become more rational, which makes us optimistic about future developments. I hope that answers your question.

Bernardo Guttmann, Analyst

Yes, that's very clear, Christian. Thanks.

Operator, Operator

Our next question comes from Luca Sari from UBS. Please, Mr. Sari, your microphone's open.

Luca Sari, Analyst

So, thanks for having my question. So two on my side too. The first one, I would like to understand the dividend pace going forward, if you can give us more detail, does anything change with the tax gains? And how you're seeing the fourth quarter in terms of distribution and 2023? And finally, regarding the ICMS pass-through, how are the clients reacting to the selling efforts? Thank you.

Christian Gebara, CEO

I'll answer the second one and David will answer the first one. Luca, this is Christian. Regarding the ICMS, as you know, we are implementing fully the reduction in all services across all segments. So it's positive because there is a reduction in price for all our plans. There is also the ability for some customers who were looking for more data allowance. Now they can upgrade their plan at a similar price that they used to pay in the past or they can now include the digital service that they were not allowed to have in the past because the budget share for telecommunications was not enough for all the services they want to acquire. So it's a very positive movement. We are working very hard to reduce the impact of taxes on telecommunications, especially after the pandemic that showcased how essential the service is. So it's a positive movement. If you look at our commercial performance, that's not only related to that, but if you see our commercial performance, we have very strong net additions coming from new customers, as well as from migrations from prepaid to hybrid offers and also very low churn. Even when we have to pass through the price increase due to inflation—which we normally do—we do it in our plans, and we have more than 82% to 84% of our revenues on a recurring basis. So we are passing on inflation, but in many cases, the inflation increase is being offset by the tax reduction. So we are optimistic going forward about our ability to increase our share of the expenditure from our customers in telecommunications technology because we're also selling a lot of digital services, as I mentioned before. I don't know if I answered that, but I will pass it to David for the...

Luca Sari, Analyst

That’s perfect, very clear. Thanks.

David Melcon, CFO

Hi Luca. In the first nine months of the year, we have already declared BRL3.4 billion, which is equivalent to a dividend yield above 5%, and there are still three months to go until the end of the year. On top of that, if you consider the additional share buyback we did in the period which is around BRL500 million, the dividend yield goes up to 5.7% in nine months. As you say, the third quarter net income, for sure, would have a positive impact on the dividend for the year as we maintain our practice to distribute 100% of the payout. The free cash flow was also very strong, and the free cash flow yield is around 10%. So we are continuing to explore all alternatives to our current capital structure to remain attractive as we have been until now.

Operator, Operator

Our next question comes from Marcelo Santos from JPMorgan. Mr. Marcelo, your microphone is open.

Marcelo Santos, Analyst

Hello, Christian, David, Joao Pedro. Thanks for taking the questions. I have two. I wanted to focus a bit on the CapEx and on the fiber deployment. Starting with the fiber deployments, I wanted to understand the strategy of the company. I saw that you accelerated homes passed in the third quarter. At the same time, this year, you’re seeing lower fiber net adds for the whole industry, and lower broadband net adds for the whole industry. So could you please discuss this a bit and maybe if you’re going to be able to reach your target before 2024? And the second question, kind of related to that, is the CapEx outlook. I think the CapEx was at least a bit higher than what we expected in the near term. How should we view CapEx for this year and for next year? Thank you very much.

Christian Gebara, CEO

Okay, Marcelo, this is Christian. Thank you for the question. Yes, I think the market accelerated after the pandemic in 2021. Now we see a performance from all players in the market that is lower than what we saw last year. I think it's normal. There was a lot of demand after the opening up of the economy, and also because our service became very essential. Everyone wants a high-quality connection at home, and fiber is the best option for download and upload. That's the reality we are all facing right now. Although the market is lower, we are the leaders, and we are getting most of the net adds in the market. We also have the possibility here to be even stronger if you consider that we are the only one with an offer that blends the best technology in fiber with the best coverage and quality perception in mobile. Vivo Total, which is our key product for convergence, is going to be even stronger. Our plan going forward is the 29 million homes passed that we discussed in the last call, which is going to be built by 6.4 million homes from FiBrasil, our co-controlled fiber network with CDPQ, 1 million from our agreement with ATC in Minas Gerais, and 21.6 million homes from our own Vivo deployment. That’s the plan for now, and we are still keeping it for the future. If you consider our customer base today at 5.3 million, we said that by the end of 2024, we would be reaching between 8.5 million and 9 million. We accelerated and currently have the largest fiber network in the country, and our plans remain as disclosed in previous calls. As for CapEx, we are not providing formal guidance but it should be around BRL9 billion. Up to now, we disclosed that, and we have to take into account that this year, we had an extraordinary CapEx of BRL400 million to integrate all assets here in our company. So we keep the same level, considering this extraordinary amount of BRL400 million to integrate Oi. So we have consistently been around BRL9 billion. That's what we disclosed about CapEx, and we are confident that we are investing in the right technology to generate more revenues in the future, both in mobile and in the fixed business, which is fiber.

Marcelo Santos, Analyst

Christian, just one question. For 2023 on the CapEx, should we expect similar levels as in 2022 or maybe lower because you don’t have the extraordinary BRL400 million?

Christian Gebara, CEO

We are still discussing it, but we expect it to be similar. We have other types of obligations related to the 5G auction. So you can consider similar levels for now.

Marcelo Santos, Analyst

Okay, thank you very much. Very clear.

Christian Gebara, CEO

Thank you for the question, Marcelo.

Operator, Operator

Our next question comes from Vitor Tomita from Goldman Sachs. Please, Mr. Tomita, your microphone is open.

Vitor Tomita, Analyst

Good morning, everyone, and thanks for taking our questions. One quick question from our side. We found it quite interesting to see the new incentive plan for managers being based on Telefonica Brasil shares. Could you confirm if there is still a part of compensation that will remain based on shares of the parent company? And on what’s the relative size or mix is between compensation based on Telefonica Brazil versus Telefonica Group shares? That would be our question. Thank you very much.

Christian Gebara, CEO

Hi Vitor, this is Christian. The long-term incentive plan before was just related to the group, group KPIs that were the shares, the award of free cash flow and also ESG related to emissions. Now it's 50-50. So 50% will be local, so it will be Vivo shares, Vivo free cash flow, and emissions, local emissions, and the other 50% will be Telefonica shares for total free cash flow and other group metrics.

Operator, Operator

Our next question comes from Fred Mendes from Bank of America. Mr. Fred Mendes, your microphone is now open.

Fred Mendes, Analyst

Thank you. Hello. Good morning, everyone. Thanks for the call. I have two questions as well. I mean, the first one on working capital. I know there are a lot of lines moving there, fiscal gains, et cetera. But just trying to wonder if it was a bit smaller, the contribution—the positive contribution this quarter—if we should start to assume this as a sustainable level or not necessarily? This will be my first one. And then my second one, more on Vivo Money. Interesting, you were growing at 60% quarter-over-quarter, give or take; this quarter was like 100%. So just wondering how you see—I mean do you think you already found the correct business model for this segment and now it’s starting to scale? And if you're already in a point of breakeven, so just wondering how we should see the scale of this business for next year. Thank you.

Christian Gebara, CEO

Fred, this is Christian. I will start with the second question and leave David with the first one, okay? Yes, you're right. I think we got on track and we know how to do it. So Vivo Money is growing a lot. We decided to show the number because it's very positive, even in not only the amount of credit given but also if you look at the number of contracts and when you compare to last year, it's growing by 6.5 times. If you compare the monthly amount of credit that we are originating every month to the same period last year, it's growing by 9.3 times. So again, we still have room to expand not just our customer base, now that we have a model that is getting better every time, but also the types of services we can offer. Today, we are lending money but not associating it with a specific purchase of a service from Vivo. We are going to start that now; we are piloting but will accelerate, relating it to smartphone acquisitions and many other types of purchases that we are deploying. So it’s positive that we could grow even more. Today, as I mentioned, BRL160 million in credit given is already a relevant platform when you compare it to other fintechs that started doing this business, and we have room to grow even more. Together with Vivo Money, we have another portfolio of financial services that we are also growing, ranging from insurance to Vivo Pay and many others that we are about to launch. Also, we bought an open banking company, Klavi. So we are very confident that we can be a relevant player in this field and also associate the financial service capability with our business, providing customers a way not only to pay but also to get credit for acquiring more of our services and products. I don't know if that answers your question, Fred, otherwise, I will pass it to David.

Fred Mendes, Analyst

Perfect, Christian. Just a follow-up on this if I may. In a more mature stage, should Vivo Money and the other initiatives combined have a similar level of financials as the rest of the companies? Or is that a completely different business and margins should be quite different? Thank you.

Christian Gebara, CEO

It's a totally different business. Even in financial services, we have different margins in different businesses. Some of them will have very high margins, and I think lending allows us to capture a lot of value out of Vivo Money. Others may also be a way for us to increase engagement with customers using our platforms to do many other things, which will ultimately reduce churn and increase lifetime value. Insurance also generates revenue for us. Depending on the business within fintech or financial services, we will have different KPIs and different models. But in the end, I think all of them will help us increase revenue, especially in lifetime value and reduce acquisition costs. So we are positive that we have started to show the market that we believe now we are ready to be a digital ecosystem, and we have all the assets to be the winner in the Brazilian market.

David Melcon, CFO

Hi Fred, I will take the first one. I mean, look, it's difficult to predict working capital in the future considering the volatility that this line has had. But one thing is important: just to consider the impact we have this quarter, plus some of the tax assets that we have still in the balance sheet, you can count on BRL1.2 billion that we will monetize in the next, let's say, seven or eight months. Elsewise, it’s something that we continue to explore to maximize working capital, but it's hard to predict.

Fred Mendes, Analyst

Perfect. Super clear. Thank you, David. Thank you, Christian.

Christian Gebara, CEO

Thank you, Fred.

Operator, Operator

Our next question comes from Feni Kanamori from HSBC. Mr. Feni, your microphone is open.

Feni Kanamori, Analyst

Hi, thanks for taking my question. I just want an update on what is happening with the Oi adjusted closing price since you had deposited the money with the court. How is it accounted in the balance sheet currently? And second question, because you have disconnected the 3 million clients, is there any change to the synergy estimates that you have given previously? Thank you.

Christian Gebara, CEO

Regarding the second question, we got 12.5 million accesses from Oi, and we disconnected 3 million due to some business criteria that we believe are the right one, and they were not the same as the time of signing. This is beneficial because these customers were inactive, and we are saving on the fiscal payments, as we pay taxes for keeping inactive customers in the customer base. Even when they are inactive, we save costs. This disconnection doesn't change the number we gave for synergies. So when we talked about our synergy level at BRL5.4 billion, we only discussed synergies in OpEx and CapEx. They are not related to customer base because we already migrated customers to Vivo, so it doesn't change the synergies we presented to the market. Regarding the price adjustment, it primarily relates to the disconnection of inactive customers. Now the three buyers presented a claim for a price adjustment, which in our case, amounts to around BRL1 billion, more or less. We had some money retained which was around BRL500 million. Thus, we claimed slightly more than EUR 1 billion in adjustment, and we made a deposit of this BRL500 million. This deposit is in a sort of account that relies on the arbitration decision. We are going through an arbitration process to evaluate if the adjustment requirement is right or not, which might take some time. The money is currently in a deposit related to the decision we expect in the coming months.

Feni Kanamori, Analyst

Thanks. Just a quick question. So in the current balance sheet that you have, where is this reflected? Is it in cash or is it in judicial deposits?

David Melcon, CFO

Let me comment on that one. So at the moment, we have it sitting in our financial debt, what we call contractual obligation. This is the BRL560 million that Christian referred to. This is on the liability side, so as financial debt at the end of September. The potential claim of BRL1 billion has not been recognized positively in our balance sheet yet since there is no final decision.

Feni Kanamori, Analyst

Thanks, very clear.

Christian Gebara, CEO

Thank you.

David Melcon, CFO

Thank you.

Operator, Operator

The question-and-answer section is over. I would like to hand the floor over to Mr. Christian Gebara for the company's final remarks. Please, Mr. Christian, you may proceed.

Christian Gebara, CEO

Okay. Thank you, everyone. I’d like to conclude our call. As you could see, strong and positive results in all areas and all key performance indicators. We are very confident moving forward; we are in a unique and favorable momentum to capture even more value in the next quarter. If you have any further questions, please reach out to us. Thank you again for joining our call. We will be in touch. Thank you so much.

David Melcon, CFO

Thank you.

Operator, Operator

Vivo's conference call is now closed. We thank you for your participation and wish you a very pleasant day.