Earnings Call Transcript - VIV Q2 2020

Operator, Operator

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to the Telefónica Brasil Second Quarter of 2020 Earnings Conference Call. Today with us, representing the management of Telefónica Brasil, we have Mr. Christian Gebara, CEO of the company; Mr. David Melcon, CFO and Investor Relations Officer; and Mr. Luis Plaster, IR Director. We also have a simultaneous webcast with slide presentation on the Internet, that can be accessed at the site, www.telefonica.com.br/ir. There will be a replay facility for this call on the website. After the company's remarks are over, there will be a question-and-answer session. At the time, further instructions will be given. Before proceeding, let me mention that forward-looking statements are being made under the safe harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the company's management beliefs and assumptions and on information currently available. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions because they relate to future events and therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the company's future results and could cause the results to differ materially from those expressed in such forward-looking statements. Now I will turn the conference over to Mr. Luis Plaster, Investor Relations Director of Telefónica Brasil. Mr. Plaster, you may begin your conference.

Luis Plaster, Investor Relations Director

Thank you. Good morning, everybody, and thank you for joining us in this conference call for Telefónica Brasil's 2020 Second Quarter results. The call, as usual, will be divided as follows: To start, Christian Gebara, our CEO, will present an update on the effects felt in this quarter due to the COVID pandemic and show how the situation is shifting our relationship with our customers; then he will go over operation and commercial performance as well as our record FTTH expansion; then our CFO, David Melcon, will comment on our cost structure, efficiency commitments, investments, and financial highlights; to conclude, Christian will comment on our ongoing ESG initiatives. We will then move to Q&A. And now, I will pass the word to Christian.

Christian Gebara, CEO

Thank you, Luis. Good morning, everyone, and thank you for taking part in our second quarter 2020 results call. I will start by talking about the impacts of the pandemic on our operations. As you know, the second quarter '20 was an atypical quarter with a drastic reduction of commercial activity in April, but starting to show early signs of recovery in May and June. Since the complete closure of our stores in March, we have gradually begun opening them up again, with reduced hours and limited capacity. In June, around 80% of our stores were already reopened to the public. This temporary shutdown had a significant impact on postpaid additions and handset sales that typically take place in our stores. That said, we have perceived a recovery since May. And in June, we only had 6,000 postpaid net disconnections and a softer reduction of 10% in handset sales year-over-year. In prepaid, we were able to revert the negative trend, having a slightly positive year-over-year growth of 0.8%, as connectivity across all segments remains essential. Overall, Vivo's top-quality value proposition continues to drive demand and sustain customer resilience. In fact, FTTH performed better in Q2 than in Q1, with record net additions. Additionally, churn decreased in all key segments, as customers are now giving more value to network quality and the overall experience. With the acceleration in the use of digital channels in recent months, the customer journey is changing fast, and Vivo is at the forefront of this transformation. By June, the acquisition of new mobile customers and migrations through e-commerce had increased 16.5%, while FTTH sales went up by 12.3% compared to March levels. Meu Vivo, our e-care platform, reached 17.6 million unique users at the end of the quarter, with a 19.2% increase in average daily users for mobile and a 33.8% growth for fixed in the last three months. Meanwhile, AURA, our artificial intelligence platform, posted strong results when we compared March to June figures. The number of contacts via WhatsApp increased 74.6%, while revenues from prepaid top-ups through AURA increased 87.1%. As you can see, the use of digital channels expanded greatly during the containment period, and these trends are here to stay, creating a unique experience for our customers. Through our ability to adapt and our robust operating model, focused on value and quality, we are able to deliver a solid operating performance and elevated cash generation in the quarter. Fiber, our main engine for future fixed revenue growth, posted the highest level of net adds ever, even with the mobility restrictions faced in the last months. As a result, we increased our customer base by 31.9% year-over-year, reaching 2.9 million customers connected. Our mobile service revenues fell by 1.5% year-over-year, which shows the limited effect caused by the pandemic on our operations. This is explained not only by the essential role of connectivity but also by our high-value client mix. In fact, 82% of our mobile service revenue is composed of postpaid revenues that are typically more resilient to macroeconomic downturns. Fiber revenues made up of FTTH and IPTV expanded 39.7% year-over-year and represent 26% of all fixed revenues. This positive evolution was unshaken by the COVID-19 crisis, and we remain confident that it will be the main growth lever of the fixed business in the future. Looking at our costs, we remain focused on accelerating the savings coming from digitalization and simplification. In the quarter, our costs saw a significant year-over-year reduction of 5.9%, leading our EBITDA margin to advance 0.5 percentage points. Lastly, we continue to expand our fiber footprint while having an efficient capital strategy focused on value. We reduced our investments in legacy technologies by 55% year-over-year, and our OpEx to CapEx over sales by 3.2 percentage points while maintaining intact levels of the investment on growth. The ratio of growth allows us, along with our strong revenues and efficient cost control to generate solid cash flows. In Q2, operating cash flow margin reached 21.2%, expanding 3.7 percentage points year-over-year and contributing to the increase of 62.6% of our free cash flow that totaled BRL 5.4 billion in the first half of the year. Our total mobile revenue decreased 5.2%, mainly as a result of the sharp reduction in handset sales, impacted by temporary confinement measures. The sale of handsets dropped 40.9% in the quarter and only began to improve when our stores gradually started to reopen. On the postpaid segment, the solid performance of hybrid in the quarter helped reduce the potential impact on revenues that fell only 0.7%. Prepaid revenues tend to be more responsive to macroeconomic downturns and fell 4.9%. However, we were able to revert the trend due to the active management of the customer base, and June figures showed an increase of 0.8% year-over-year. In the second quarter, we again reaffirmed our mobile leadership, sustained by customer preference and gradual commercial recovery. Our overall mobile market share stood at 33%, the highest in 14 years, and a significant improvement of our postpaid churn reduced by 0.31 percentage points year-over-year, reinforcing our leadership in the segment. Prepaid registered the highest level of net adds in 5 years, with 267,000 net adds due to our continuous efforts on client acquisition and active customer base management. Of the 260,000 net disconnections in the second quarter, only 6,000 were in June. In the second quarter, we regained our fixed revenues that dropped 5.1% due to the maturity of our legacy corporate-based services and our decision to stop selling the FTTH IPTV, while we continue to see solid trends in the growing side of the business. Our FTTH and IPTV revenues reflect the success of our accelerated fiber deployment, with FTTH revenues rising 47.6% year-over-year, while our IPTV was up 22.3%. The addition of higher value FTTH and IPTV customers continues to exceed expectations, improving the customer mix and driving ARPU growth. For the second quarter in a row, we had record fiber net adds of 210,000, contributing to the growth of broadband and Pay TV ARPU's. FTTH access in Q2 reached 2.9 million access, representing a 32% year-over-year increase, leading to an 18% year-over-year rise in broadband ARPU to BRL 74. In conclusion, Vivo is ready to capture this opportunity, thanks to our consistent investment in the largest fiber network in the country.

David Melcon, CFO

Good morning, everyone, and thank you, Christian. On Slide 12, we show how our strong cost reductions help us offset the revenue drag caused by the economic slowdown. Our costs reduced 5.9% year-over-year, leading to an increment of 0.5 percentage points to our EBITDA margin that closed the quarter at almost 40%. This quarter suffered from some atypical but temporary cost effects, mainly due to the COVID-19 crisis. Provisions, for example, reached 3.5% of gross revenue, a 1.1 percentage point year-over-year increase with payment delays more concentrated in B2B, but with minimum cash impact. Cost of goods sold were down 34.6% as a result of lower handset sales in the period, while personnel costs fell 6%, given the temporary workday reduction and benefits from government measures. Cost of services rendered increased 4.8% this quarter due to higher interconnection costs associated with the seasonality of IP traffic reported last year. Our G&A and others line was also affected by temporary effects and contingencies benefited by ongoing reductions. However, the most significant factor for our consistent cost reduction and efficiency continues to be our digitalization and simplification efforts. In the second quarter of 2020, we had 75% of our customers receiving e-bills, a 12 percentage point year-over-year increase, and 60% of the payments were made through digital platforms. We have reduced by 21% the number of call center calls through this growing use of digital channels like Meu Vivo and AURA. Those initiatives are critical. As a result, we achieved consistent OpEx reduction while also contributing to an improved user experience by responding to our customer demand. Our CapEx contracted 19% year-over-year to BRL 1.9 billion, prioritizing investment in growth, which currently accounts for 70% of our expenditures. The CapEx allocated to fiber technologies increased more than 5% year-over-year, while legacy expenditures decreased by 55%. I'm pleased to share with you that we are launching 5G DSS in 8 major cities by the end of July, and our network sharing agreement with TIM has been approved by both regulatory and competition authorities, with the first initiatives already underway. These accomplishments confirm that the company is on the cutting edge of technologies and constantly focused on increased rationality.

Christian Gebara, CEO

Thank you, David. I would like to conclude today's presentation by saying that we aim to deliver high-quality connectivity solutions to our clients and superior remuneration to our shareholders. Vivo also wants to contribute to society through its commitment to ESG by being socially responsible and helping to build a more sustainable environment. In the short term, some of our efforts include our donations regarding the COVID situation. At Vivo, we are aware of the pressure on the health system in terms of supply shortages and the families facing financial difficulties during the pandemic. For that reason, we donated BRL 38 million in 12 states across Brazil for the purchase of hospital supplies and equipment as well as food provisions for vulnerable families. Another initiative already in place is our recycling program, which has collected 111 tonnes of electronic waste since 2006 through more than 1,600 collection points available at our stores and other strategic areas across the country. Moving to our medium and long-term initiatives, we have just announced a comprehensive project for distributed generation using solar, hybrid, and biogas energy, which will provide 80% of our low voltage energy consumption, covering 23 states and reducing costs while generating local development. Finally, I'm glad to say that Vivo is a carbon neutral company with 100% of our energy being renewable, and our direct emissions are completely offset. These are some of the many initiatives that Vivo performs either on its own or alongside the Fundacao Telefónica Vivo in helping society navigate towards a more sustainable present and future. Thank you, and we can now move on to the Q&A.

Operator, Operator

[Operator Instructions]. Our first question comes from Maria Tereza Azevedo, Santander.

Maria Tereza Azevedo, Analyst

Thank you for the call, David, Christian, and Luis. My first question is on the fiber strategy. Is the idea here to sell the control, allow more leverage, and maybe buy regional ISP providers as well? And is it fair for us to assume that the strategy is going to be that you're going to keep your own fiber in the multi-strategic markets? And then you will share a neutral network in the middle market, similarly to what you're doing on the mobile rent sharing agreement?

Christian Gebara, CEO

That's Christian answering. So I couldn't get 100% of what you asked. The idea is that we're going to continue growing fiber with different models, okay? We are going to continue with organic growth. We have reached around 13 million homes passed, and we're going to add maybe another million at the end of the year, reaching 14 million homes passed. We're going to initiate partnerships, such as the one with American Tower, that we plan to add another 800,000 homes passed in four years. We also have franchising models established, with three cities having a franchisee where 100% of the CapEx is with the franchisee, and we only benefit from the royalty. We have another partnership with Fenix Fiber in different states of Brazil, where we have more than 10 cities. Now we're launching this new vehicle that I just spoke about, which will be a neutral network as you asked. We're going to be the core client, but there will be other clients also using this network. Our initial contribution will be 1.1 million homes passed, and Telefónica and our financial partner will also contribute. Through this vehicle, we plan to build more than 5 million homes passed in the next four years while also pursuing our organic growth and the growth through our partners. I hope that answers your question.

Maria Tereza Azevedo, Analyst

Perfect. Christian. And my second question is on the mobile market segmentation and potential market repair. Can you please comment on the strategic value that you see for Oi mobile assets? And is it mostly on the capacity and spectrum? Or do you see any threats to your high-end postpaid subscriber base in the case of a potential wholesale player?

Christian Gebara, CEO

I think we are, like, as you know, we have a binding offer that we submitted—a second one on Monday. They have a value there. We are doing that in conjunction with TIM and Claro. We believe that there are many synergies in the deal related to network management, customer management, channels, and commercial activity. So I think together, the two of us will be able to capture the opportunities. Moreover, considering regulatory and antitrust issues, I think the three of us acting together will be able to mitigate concerns. We are speaking about three operators that have been acting in this market for decades. The migration of customers to our networks will be easier, and we have the tower and spectrum to support new customer contributions that we would inherit if this offer goes through. Of course, there are some synergies in having more spectrum and also optimizing the situation or the spectrum map, combining some frequencies that Oi has and we also have in our portfolio.

Operator, Operator

Our next question comes from Marcelo Santos, JPMorgan.

Marcelo Santos, Analyst

Christian, David, and Luis. I have two questions. The first is on the fiber carve-out that you announced you're doing. Could you please provide a bit more detail on what components of the network would actually be carved out? What's the target geographical expansion that this carve-out is going to seek? Is this going to be mostly cities in Sao Paulo? Or is it something more nationwide? And also, if this is going to focus more on converting maybe your corporate clients? Or are you going to new areas where you don't have copper with this network? The second question would be about the DSL subscribers, which the pace of decline seems to be deteriorating. In the past, I think you have mentioned that you thought that fixed revenues could start turning around maybe by the end of the year. I know this was pre-COVID, but I think that was more or less the expectation that you would have the new revenue sources overcoming the legacy ones. Is this still reasonable to expect? These are my two questions.

Christian Gebara, CEO

Marcelo, you have several questions here. If I forget something, please remind me later on. We are carving out 1.1 million homes passed from the central to the customer premise, including the customer premise equipment. We are adding this to the new vehicle, which will operate outside the state of São Paulo and in cities where we deployed FTTH where there was no combination of FTTC and FTTH. This means cities where we have built FTTH that were beyond GVT's prior footprint. This is not going to happen in São Paulo; we plan to focus on organic growth there instead. The growth of the fiber network is going to come from more than 200 cities across various states, but we are not providing the specific locations. We are not growing the vehicle in the state of São Paulo; that will remain focused on our organic growth. Secondly, regarding the DSL; yes, you are correct in recognizing the decline. When we show the number of growth in broadband, we cannot overlook the 47.6% growth in FTTH and the lack of growth in FTTC and DSL, resulting in a decline overall. We are remedying this by overlaying the network. When you ask about when the mix would be positive, our slides show that 57% of our growth in fixed is already from new growth technologies, rising 11%. There is still a focus on legacy technologies, which is decreasing but is also impacting our performance. However, we believe that prioritizing CapEx on new technologies will yield better profitability and cash generation.

Operator, Operator

Next question comes from Rodrigo Villanueva, Bank of America.

Rodrigo Villanueva, Analyst

Christian and David, Plaster, I have a couple of questions. The first one is regarding accounts receivable. It seems to me that on a net basis, they declined by around 5% both quarter-on-quarter and year-on-year. And it seems that you have not been facing any issue to collect despite the COVID crisis. I was wondering if you could provide more color on the performance of accounts receivable. And if you would expect to see some sort of deterioration during the second half of the year? That would be my first question.

David Melcon, CFO

Rodrigo, this is David. If you look at our balance sheet, particularly the budget regarding accounts receivable, which is very relevant this quarter. There have been different behaviors, one in B2C and another in B2B. B2C represents 75% of the total revenues of the company and it has been very resilient to the pandemic's impact during this quarter. The budget for this segment is in line with previous quarters and we expect it to continue going forward. As for B2B, which represents around 20% of total revenues, it has been more impacted, especially among SMEs; they're more focused on optimizing and protecting liquidity. Nevertheless, we are monitoring closely and adopting necessary measures, such as negotiating debt and offering the option of paying installments free of interest and fine. In summary, the budget is under control and we believe the worst impact is already behind us.

Rodrigo Villanueva, Analyst

Understood, David. Very clear. The second question I have is related to the use of Huawei equipment. We have seen different comments in press articles regarding the potential for Vivo to use Huawei equipment going forward. So I was wondering if you could please clarify if you have already reached a decision regarding the use of Huawei equipment in your network?

Christian Gebara, CEO

Rodrigo, we are following closely the developments. We ensure that we have all security measures in place for every vendor. We apply the highest safety standards and monitor everything that occurs regarding all vendors, especially regarding the decisions of our regulatory body and government. As you understand, we embrace a multi-vendor strategy, which is beneficial for both price and innovation. Currently, we are maintaining our strategy while monitoring any developments that may affect our 5G rollout. So far, we continue to follow our security and protection standards aligned with the Telefónica Group.

Rodrigo Villanueva, Analyst

Christian, very clear. And one final question, if I may. When Vivo considers new fiber-to-the-home clusters, is there a minimum threshold in terms of population living in those areas that you consider?

Christian Gebara, CEO

We have different models for various types of cities. We are primarily focusing on larger cities, as we have more than 200 cities in Brazil, mainly state capitals with some exceptions in the north. We will keep expanding into larger and midsized cities. For the vehicle itself, we plan to focus on midsized cities. For the smallest ones with below 50,000 inhabitants, we aim to utilize a franchise model that allows franchisees to deploy CapEx independently, while we receive royalties. In addition, we'll consider smaller cities close to larger centers for infrastructure needs.

Operator, Operator

Our next question comes from Frederico Mendes, Bradesco BBI.

Frederico Mendes, Analyst

I have two questions here as well. I mean, the first one is on mobile phones. I mean, we saw a decrease in ARPU of 2.6% year-over-year. So I want to understand this trend because historically, the net adds on the postpaid segment have been more towards the hybrid plans, which does not seem to show strength. What we saw were some weaknesses with these net adds over the next months, which were affected by the pandemic. So I want to understand if maybe, during the pandemic, Vivo focused more on downselling in order to keep discussing with customers to mitigate the impact or if there is something else behind these ARPU results? The second question is on the FTTH. When you have customers on copper and want to upgrade to FTTH, are you managing to charge a higher price? Or is it a price that the client can afford? Also, can you share with us the ARPU for FTTH customers only?

Christian Gebara, CEO

Fred, this is Christian. Yes, the ARPU reflects multiple considerations quarter over quarter. The postpaid was impacted, especially in new acquisitions because most of our sales occur in stores, which were closed. When we closed in March, we began to reopen them gradually. While net additions of postpaid were negative earlier in the quarter, they did recover towards the end. The situation is improving, and while we are not facing significant churn, we see improvements as commercial activity resumes. Migration from lower-tier plans is somewhat reflected, and we anticipate ARPU will recover due to this resurgence. Our ability to launch new plans was hampered because our stores were closed, but we've just launched a new pure postpaid value proposition. Regarding migration, we can charge a higher price due to different speed options, IPTVs, and additional services. I'll provide you with the exact ARPU for FTTH later.

Operator, Operator

Next question comes from Tito Ferraz, Itaú.

Tito Ferraz, Analyst

My first question here is regarding CapEx levels. We've seen CapEx levels decreasing with less focus on deploying a copper network. Can you give us some more insight regarding what would be a reasonable level of CapEx going forward as a percentage of sales?

Christian Gebara, CEO

Tito, this is Christian. We're not halting investments in growth, especially for 4.5G and FTTH deployment. Our CapEx for technology continues to reflect this endeavor. The allocation for fiber increased 5.3%, but we're cutting back on legacy technologies, focusing more on growth potentials. While we aren’t providing guidance for CapEx right now, we anticipate improved performance this quarter and in the last half of the year, assuming commercial activities ramp up. We've been judicious with CapEx concerning legacy technologies.

Tito Ferraz, Analyst

Okay. And just a quick follow-up question here. Looking forward at your agreement with TIM, when can we expect some results on CapEx and OpEx savings from this initiative?

Christian Gebara, CEO

Yes. Good question. We've achieved all approvals from regulatory and antitrust agencies, so we are ready to start working together. However, it will be too soon this year to see tangible results. We are adapting our networks to this agreement. I believe next year will be the first year we will begin capturing those OpEx and CapEx benefits.

Operator, Operator

Next question comes from Walter Piecyk, LightShed.

Walter Piecyk, Analyst

Over to the fiber. Is that the long-term game plan? Is there potentially an opportunity to sell those customers to AT&T's Sky business? And then even beyond how you...

Christian Gebara, CEO

Sorry, sorry, you were on mute. Can you start the question from the beginning because we just got the last word?

Walter Piecyk, Analyst

Sure, sorry. You said a lot on the call about taking CapEx or moving the DTH customers away. Obviously, we can see the sub-growth there going down from satellite, and you're shifting to fiber. Is the long-term plan to continue to do that? Is there an opportunity maybe to sell some of those customers to Sky? Conversely, could you—if you can get a really good deal on Sky—just buy them for the customers and then over time, migrate them to ADSL? And then in general, again, just thoughts on Pay TV; does it even make sense to offer a Pay TV product? Isn't it better to become a broadband provider and let the customer figure out their own over-the-top Pay TV services, thus getting much higher margins for your business? If you could just talk about those issues, I'd appreciate it.

Christian Gebara, CEO

Walter, we are not leaving Pay TV players in the market. Throughout our offerings, we have around 800,000 IPTV customers and over 300,000 DTH customers. With more than 13 million homes passed and almost 3 million FTTH customers, we maintain IPTV as the model for the future, since many customers still demand it. We are going to continue to operate IPTV for triple play customers who prefer it. However, like you said, most customers just want broadband, leading us to launch offers like fiber service plus Netflix. In terms of customers migrating, if there's an option that makes sense for us, we are open to discussions. However, we currently do not have any proposals regarding Sky. For clarity, over 50% of our wireless subscriber base has LTE-enabled devices. I don't have the exact number right now, but it is indeed a growing segment.

Operator, Operator

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

Christian Gebara, CEO

Thank you all for participating in this call. As usual, we are always open for further questions. You can reach out to our Investor Relations team. Thank you all, and I wish everyone a good day. Goodbye.

Operator, Operator

Thank you. This concludes today's Telefónica Brasil 2020 Results Conference call. You may disconnect your lines now. Have a great day.