Koninklijke KPN N V 's KKPNF CEO Joost Farwerck on Q2 2020 Results

Thank you, Bisera, and welcome to our second quarter results presentation. We delivered solid performance in the second quarter with stable adjusted EBITDA after leases and significantly higher free cash flow excluding divestments. Our balance sheet and liquidity position remain strong, and we are living up to our 2020 dividend commitments. Demand for KPN's essential connectivity services remains high, and our networks have proven to be robust through a period of unprecedented demands. The execution of our strategy is well underway, and we saw positive developments particularly in the competitive consumer market where broadband and postpaid net adds showed a clear improvement trends, and we see some first signs of bottoming out there. In B2B we made again progress with customer migrations, though we recognize several challenges remain in the B2B segment as the economic activity in the Netherlands has decreased. As we continue our open wholesale model, we see further growth in our wholesale broadband portfolio, and we also continue to ramp up our fiber rollout. I would like to highlight a few key figures corrected for divestments. Adjusted revenues declined by 3% year-on-year. Growth in professional services in business and in wholesale was offset by lower revenues from mobile and a roaming effect and fixed voice services. Adjusted EBITDA after leases was flat as the effect of lower revenues was fully offset by strong cost savings. Free cash flow increased 70% year on year, 277 million euros, and ROSI, which we will now be reporting semi-annually, increased 80 basis points year-on-year to 9.8%. Chris will give you more details on our figures later in this presentation. The estimated net effect of COVID-19 on group financial result was slightly negative in the second quarter. The estimated negative net effect on adjusted gross profit was around 5 to 7 million euros driven by lower revenues from roaming and late IT projects. This was partly offset by higher fixed and national mobile traffic. The estimated net impact on adjusted indirect opex was approximately 6 to 11 million euros positive, driven by for example lower cost related to travel, learning and development, facilities, FTE cost, etc. Uncertainty continues about the impact of COVID-19 on the Dutch economy and therefore KPN, and with the Netherlands expected to move towards a recession, the ultimate impact remains difficult to predict. While we expect to see a higher negative year-on-year effect of roaming in Q3 due to the summer holiday season, we remain able to adjust our cost base in line with developing economic circumstances. Our revenue risk assessments by type of customers is unchanged compared to the first quarter. Importantly, revenue in customer segments that are most exposed to the negative impact of COVID-19 accounts for approximately 10% of total group revenue. We remain committed to our strategy and to our 2020 outlook as provided in January this year. We delivered in the first half of the year an outlook for adjusted EBITDA after leases, capex, and dividend per share is reiterated. Combination of COVID-related downward pressure on revenues offset by strong cost control enables us to reiterate our 2020 outlook for adjusted EBITDA after leases. We reiterate our capex outlook of 1.1 billion, and we also reiterate our dividend per share outlooks of 13 cents an interim dividend of 4.3 cents will be paid in August. We remain fully committed to grow free cash flow with at least mid single digit percentage. There could be some limited downside risk due to a potentially worsening trend in customer payment behavior as a result of COVID-19 in the second half of this year, however we are not observing this and this is not impacting us today. We remain committed to grow free cash flow with at least mid single digit percentage. KPN is well positioned to absorb the short-term and medium-term effects of COVID-19. Visibility of impact of the pandemic into 2021 is limited, so we remain fully committed to our three-year strategy.

In the first six months of the year we have seen solid progress on our strategic pillars, which as a reminder are building the best network, focus on profitable growth segments, and accelerating simplification and digitalization. We made good progress in building the best converged smart infrastructure. On fiber we added 76,000 additional households in Q2, which adds to a total of 250,000 households since we started to roll out last year. We've also significantly improved access speed for our customers. To date we upgraded a total of nearly 1,500 mobile sites with the latest equipment, and we only have approximately 80,000 legacy lines left to migrate by the end of 2021. We switched off ISDN2 technology and we are currently migrating customers to our new OSS environment, reducing the lead time of new broadband customers from around two weeks to three days, strongly improving the customer journey. We have one of the largest fiber footprints in Europe with 2.6 million households or 32% of the nation covered by fiber to the home, and 55% of households covered by fiber to the cabinets. Our ambition is to cover more than 40% of households with our own fiber network by the end of next year, and we expect to continue the fiber rollout thereafter as we are just getting the machine up and running. We acquired a small local fiber network consisting of 6,000 homes passed in May, and this was a good opportunity to enlarge our footprint at value creating terms. This month we successfully tested our next-gen PON technology and reached up and download speeds of 8.5 gigabit per second, and this only shows what our investment in technology will bring to our customers in the future. We will continue to develop this to further shape the digitalization of the Netherlands. As I mentioned, we added 76,000 households to our fiber network in the second quarter. We activated 32,000 customers, which means a solid activation rate of 47% over the past 12 months. Currently we are rolling out an average of 5,400 to 5,500 fiber to the home connections a week. We are active in 83 areas, and we are starting construction in the largest cities of the Netherlands. We are committed to our fiber investments and we see continued commercial proof points that our fiber strategy is driving value. Fiber is now more than half of our consumer broadband net adds. We see a higher network penetration in fiber areas. Fiber ARPU is 9% higher than copper, driven by higher inflow ARPU and better take-up of value-added services and convergence. Penetration on fiber is higher and NPS is higher, resulting in lower churn. Consumer fiber revenues grew 6.3% year-on-year in the last quarter, driven by growing base and attractive ARPU. Overall, fiber investment generates returns that exceed the group's cost of capital and have a positive net present value. While the speed of our mobile network modernization was somewhat impacted by COVID-19, KPN upgraded approximately 560 sites with the latest mobile radio equipment in the second quarter, and this brings the total modernized sites to around 1,500 since we started in September last year. In the latest spectrum auction we obtained an attractive combination of frequency licenses totaling 75 megahertz for a total of 460 million euros. We're satisfied with this outcome and the new licenses allow us to further improve the quality of our mobile services, and we are excited to launch 5G services for our customers tomorrow. KPN initially foresees the most potential of 5G for new business applications such as innovations in the field of safety, healthcare, mobility, logistics, and the manufacturing industry. The first new services enabled by 5G are a first step in 5G development; more new developments will be added in the coming year, and after the auction of the 3.5 gigahertz band which we expect in 2022, a greater improvement in speed and capacity will be possible.

Let's now move on to our second strategic pillar, focusing on profitable growth. In consumer we aim to deliver sustainable value through our continued focus on the high value KPN brand and by running a targeted household approach. We've reached some important milestones integrating the Telfort brand and launching KPN Hussels. In B2B we migrated a significant part of our customers to our target portfolio and we are rationalizing the IT environment. We're simplifying our product portfolio. However, due to COVID-19 impact, we expect B2B end-to-end adjusted EBITDA after leases to stabilize in 2021 based on current estimates. In wholesale we see continued growth of our wholesale brand access and whoa portfolio. Our third strategic pillar is accelerating simplification and digitalization of our company. KPN made good progress in the digital transformation program by migrating customers to a new operating support system. This reduces the lead time of new broadband customers and strongly improves the customer journey. Also, we've shut down three data centers and terminated several applications, resulting in structural cost savings. The second quarter was the first in which we saw the full effect of COVID-19 measures on the Dutch society. While impacting performance in some areas, this dynamic also underlined the importance of KPN's efforts to improve and enhance the quality of the Netherlands' digital infrastructure. This work is essential to the country's economic recovery as well as its ability to address the ecological and social challenges of the post-COVID world sustainably. Throughout the crisis we have ramped up incident monitoring and waived fees for cyber security support for hospitals. We offered free connectivity cards for vulnerable groups to stay connected and be homeschooled during the COVID-19 pandemic, and we signed the Green Recovery Statement, calling on the government to start the COVID-19 recovery plans sustainably. Our ESG efforts are recognized by various external benchmarks. We are on the A-list of CDP, we have a triple-A status at MSCI, and we have a Gold Class distinction at Dow Jones Sustainability Index. Let's move to the performance of the segments. In the second quarter, fixed consumer revenues were slightly up while mobile service revenues declined 6.5% year on year, partly driven by lower roaming revenues as mentioned before. This trend is expected to worsen in Q3 due to lower roaming revenues during the holiday season. The market remained highly competitive with three players focusing on converged customers. Competition from local fiber operators in rural areas and mobile competition now focusing more on the high-end unlimited propositions. NPS increased year on year to plus 15. We are highly valued for our best-in-class network, converged services, and our fiber strategy. Also, we are pleased that our fiber network is recognized as the best fixed broadband network in the Netherlands by the Dutch Consumer Association.

A few words on our consumer KPIs. In the quarter our converged customer base returned to growth. Converged households grew by 3,000 customers, and we added 30,000 converged postpaid customers. Looking at our broadband base, we added 17,000 fiber customers in the quarter while the total broadband net adds declined with 3,000. In mobile, our customer base remained broadly flat. So this is for us an important trend to focus on. This quarter, the improvement of consumer net adds was driven by improvements in commercial strategy on fiber, our focus on the fiber strategy, our strong unlimited propositions we introduced, our new marketing campaigns, and our super Wi-Fi proposition in the Netherlands. Also, we see that existing customers value the quality and stability of our network, especially in this COVID crisis, resulting in lower churn. Our focus on value is demonstrated by fixed ARPU growing 5% year-on-year and mobile postpaid ARPU being 17 euros for the sixth quarter in a row. In B2B, we completed the sale of KPN Consulting on the 1st of April, and as a result the second quarter results do not include any KPN Consulting revenues. Corrected for divestments, business revenues declined 5.7% year-on-year, and this reflects the strategic actions in the segment and it is also related to COVID-19 as we saw lower revenues from roaming and IT projects in particular. We have further simplified our B2B product portfolio and we removed already 37% of our offerings. We are on schedule to reach the 50% target by the end of next year. NPS in B2B increased to plus 2, driven by improved scores at SME and LCE customers. KPN is mainly valued for quality and for reliability. The operational transformation of our B2B segment is taking shape. We continue to simplify our product offerings and most of our customers have now switched to a future-proof portfolio such as KPN Klein Zakelijk for SOHO, KPN1, and KPN Smart Combinations. We have now migrated 84% of SME and 72% of LC customers. We completed the phase out of ISDN2, which is an important milestone not easy in COVID time since migrations that require physical access to offices are often postponed. Then on our customer segmentation within B2B, in the first half of the year, in the first six months of 2020, revenues from SME and LCE were declining, mostly driven by mobile ARPU and the proactive customer migrations. Revenue from the major integration customer segment increased as a result of more project related work.

Now let's move to wholesale. Correcting for the sale of NLD, adjusted revenues in wholesale increased 1.2% year on year, driven by solid performance in our fixed portfolio. Mobile revenues were broadly flat despite lower roaming revenues. Wholesale added 16,000 broadband lines and 7,000 postpaid SIMs in the quarter. During the quarter we also renewed a new five-year MVNO contract based on commercial terms with UFO. Following the court ruling on wholesale fixed access regulation in March this year, KPN has reconfirmed its open wholesale policy based on its voluntary offer for ODF wholesale broadband access and VULA, and the long-term contracts it has in place with several parties. KPN believes its open wholesale policy is in line with the symmetric access policy outlined in the European Electronic Communications Code. While we have seen a slightly declining broadband base in consumer, the performance of our wholesale segment remained solid. This contributes to our strong and stable broadband network share in the Netherlands of around 52%. Then over to network operations and IT. Adjusted operating expenses after leases declined 9.3% year on year for the segment, mainly driven by reduction of personnel, simplification of networks, IT rationalization, and contract renegotiations with suppliers. We are working with our main contractors to protect the 3,000 jobs involved in our fiber rollout, and we maintain the expertise around network build out in the Netherlands in spite of changing dynamics in the Dutch construction market. We are securing long-term construction capacity to safeguard our rollout plans. Now this ends my part of the presentation. I would now like to hand over to Chris to talk you through our financials. Thank you.

Let me start and Chris will take over. When it comes to 2020 and 2021, we are fully committed to our strategy, and in that strategy we have a framework of a capacity of 1.1 billion. In that 1.1 billion we have to operate, and that is what we currently do. So I'm happy with the results of Q2, that's why we can reiterate our 2020 EBITDA, capex, dividend guidance, and we're convinced that we remain committed to growth in free cash flow for 2021. Visibility of the impact of the COVID-19 crisis is currently limited, so also there we remain fully committed to our three-year strategy. We have a cost saving program, we had one of three years, this is the second one, and as you can see today we are a little bit ahead of the plan. So if everything works out well, I'm convinced we can upgrade that plan in the future. Maybe you can add something on opex and capex.

Look, thank you. Another question on our acquisition of fiber lines. First, let me note that the amount of money we spend on it is relatively small compared to the total capex budget. We have a 1.1 billion capex envelope. I think to this point we spent one percent or less than one percent actually on fiber M&A, so we should not get carried away with the amount of M&A we can do in this space. The funny thing is, because what we buy is actually a network with a very small operation, mentally I tend to think of this as M&A which you fund out of your balance sheet. Unfortunately, IFRS requires to classify this as capex, I can't frame it as a business combination but as a network acquisition because we're rolling out fiber ourselves and we're buying small networks without too many activities on the side. So while mentally this has emanated from your balance sheet, effectively we have to present it as capex. How do we look at this? It's opportunistic. It's on top of our organic fiber roll-up plan where we have a very specific model and approach, select regions, direct areas, select zip codes where we roll out fiber. But sometimes you bump into opportunities to accelerate and add more fiber to your fiber portfolio. We tend to look at it from a couple of lenses. First of all, buy should be never more expensive than make. We always ask ourselves the question: if you wanted to put that fiber in this area, would it be more expensive or cheaper to buy it? Secondly, is there a real value creation opportunity because you add a network where penetration is really low and your penetration is what drives ultimately the fiber case? So can we add penetration to the network that together will drive a case? And how much is there to do? Hard to say. It's opportunistic. We don't pursue a truly active M&A strategy, but once you bump into opportunities you look at it. So it's looking at probably a couple of percentage points of the total capex envelope at max. I can't tell you how much we do when and where because in these transactions we are in this opportunistically. If we see a good deal and create value, we'll pursue it; if not, we're happy to walk away. So it's all about value creation to shareholders, but it's a couple of percentage points of our capex envelope that's kind of the maximum of what we could do. And I said unfortunately IFRS requires to classify it as capex, although mentally this is you know an acquisition in front of your own balance sheet.

Thank you. Yeah, this is for us super important. I said before, we have to draw a line in the sand when it comes to our broadband and our mobile base in the consumer market. After eliminating the Telfort brand, we lost customers quarter by quarter over the last...

I'm seeing a positive trend here with minus three thousand. I would say COVID is not against us, but it's really about the way we launched the new propositions, it's about the way we combined operations and commercial people in the regions to sell fiber and to connect people to fiber, it is about how we launched unlimited our new marketing campaign. So the market didn't stop rotating. By the way, we saw an inflow on the wholesale side of broadband customers of sixteen thousand this quarter. We stabilized. So for me these are positive signals and we will do all we can to improve this quarter. Our base in consumer market on the mobile side, we see the positive effect of our push to unlimited propositions which is to support our RPU. Of course in Q3 we always have the biggest impact of roaming, but in general this unlimited proposition is really supporting our view and the base is also developing in the right direction. So this is not a coincidence, it is very important. Every week we look at this as a board and the company's fully focused on improving our base term. Thank you very much.

In B2B, the end-to-end stabilization is a very important target for us. In general we're on track. In SME we migrated 84% and I think in SME we will stabilize this year. LCE migrated a lot above 70%. So it really has to do with the impact of roaming that I think we're not going to make it this year in stabilization. Having said that, when we look at the whole value chain end-to-end and knowing where we are in the migrations, we are convinced that we can make it soon next year.

Yeah, so compared to other telcos, our roaming impact is limited since we as a Dutch incumbent are competing against T-Mobile and Vodafone in the Netherlands and they have international networks, so they offered better all-net propositions to B2B customers. Having said that, there's always an impact outside of EU. So this is really a limited amount of revenues, but all we know it will impact our revenues a bit in Q3 as it did in Q2. On wholesale, we have been regulated for 20 years. Last quarter we won a case against our regulator and suddenly nowadays we're no longer regulated in fixed access in the Netherlands. We appreciate regulation and we understand we need a supervisor in the Netherlands, that's very important. We're not against regulation. I think having a regulatory framework is good. That's why we suggested to follow our open access model in the Netherlands with all the pricing on the services we do on a wholesale side that used to be regulated, and we follow the same price scheme as before. The only thing we do not like is the idea of getting regulated on tariffs, and that's why we have these discussions with our government. We appreciate regulation, we think it fits in the European regulatory framework, and I think that we can make a good step by using the open access model of KPN as a voluntary model introduced by us, which is from a legal point of view possible as the new regulatory standard in the Netherlands.

Yeah, your first question was referring to the roaming effect if I'm not mistaken and the mobile consumer RPU. So we see an improving trend on mobile RPU because not that long ago we were facing a decline in RPU every two quarters and now for the sixth quarter in a row we are around 17 euros. And we stabilize our base. And that's all related to our commercial approach in the market. So underlying development is good. Like Chris just mentioned, there's a roaming effect in our current revenue trends and Q3 is always a bit higher on the roaming than Q2, although we have this EU roaming, so in EU countries it doesn't make any difference if you're in the Netherlands or outside, same tariff applies there. So it's really outside EU we're talking about on roaming. So the effect in Q3 on roaming will be a bit more than in Q2, but not significantly.

Well, the base for sure is improving in B2B. We added 61,000 net adds in this quarter if I'm not mistaken. So I think there's a lot to repair in the Netherlands when it comes to mobile. We all invested a lot in networks. We have the best networks in Europe in the Netherlands. So it's super important that we all understand that we have to create value. This market in the Netherlands is eliminating lower price points and moving more to unlimited high priced. For us about 30 euros, 27.50 in the package in a converged package. So I'm a little bit positive here, but let's wait and see. But today, currently, it's moving a bit in the better direction, to put it that way. Yeah.

Thank you. Yeah, so when corona started, we froze all our reorganizations. We worked on how we could facilitate our people working from home. But having said that, we still reduced on FTE because we had a couple of reorganizations already ongoing. And end of this quarter, we announced that we restart our reorganizations because we think it's not fair to our people and doesn't make any sense to keep waiting with improving the operating model of KPN and simplifying our organization. And our people agree, as long as we do it according to plans and in a fair way, and that's what we always do. So we restarted our reorganizations and we will in the coming six months reduce people, but having said that, in the way we always do, in a very decent way. On opex reduction, we're running ahead of plan. And like I just said, we are ambitious, so we would like to beat our plan. And not for today, but if we continue like this, we will upgrade the program.

Yes, it's really all about COVID. We saw this is really all about the impact of the pandemic that's uncertain to us. KPN underlying is delivering as planned, for even better plans. Sometimes the ocean I like each other, what if COVID had not happened, what kind of quarter, half year would we have had? So I think KPN underlying is delivering according to plan. It's the uncertainty around COVID, for example the payment behavior or the depth of the recession, that is hard to gauge. So that's kind of the only risk that we're flagging.

Yeah, so when we look at the fiber case, we see the proof that it's working. We are doing better than the original fiber case we built 10 years ago on RPU, on penetration. We're doing good and we aim to do better in existing fiber areas because having a penetration of 60 still means that 40 is not active yet. So for us it's important not only to focus on new built areas but also on the existing footprint we built over the years. Currently we're working on a plan to roll out 1 million until the end of next year and that is very important. The machinery we're building means that we can build fiber against lower cost per household because the more we build, the lower it gets, the more efficient we will become. We innovated a lot in the rollout of fiber, so we can go faster in areas to connect more houses and against a lower price. So that is our focus for now. Does it make any sense to stop end of next year? I don't think so. So we will probably keep on building fiber, but of course it's very important to stick in our capex framework as well. So that's where we are on fiber. We're doing good, we're scaling up, and it's against the lower cost per household. The balance between wholesale and consumer, I would say, we've been playing this game for a long time. I think over the last quarters we saw outflow on consumer and a bit higher inflow on wholesale. So it's our leverage on the consumer side. Having said that, it's not healthy to lose that many customers in consumer for a couple of years in a row. So I'm satisfied with the results of this quarter that we more or less stabilize that consumer base, a bit of a loss minus three thousand, but against that the inflow of seventeen thousand or sixteen thousand on the wholesale side means that others are losing customers and they are moved to our network. And all in all, that balancing act between consumer and wholesale delivers a lot of value, I think.

Yeah, I apologize because the sound is not that good, so difficult to hear you correctly. But if I'm not mistaken, you ask the question around mobile RPU of the 17 euro and on the Telfort customer migrations. Let me start with the Telfort customer migrations. We migrated the full mobile base of Telfort to KPN in a very smooth way. That was done and all these customers have migrated to KPN against the former Telfort price point. So that's done. On the broadband side, we are going to migrate the Telfort customers in the second half of this year to KPN. We're piloting that now with friendly users as we call it, but it's also very important that it goes smoothly in a couple of batches and then to the new environment. So that's an important migration and we will do it in the second half of this year. And once that's done, the base is more stabilizing, so that is important. You're right there.

To start with your B2B question. SME is not the largest segment when it comes to revenues, but from a profitability point of view it is very important for us. So it's the highest profitable B2B segment for us. Why is that? Because we standardized the portfolio, it's called KPN One. We can migrate 82% of the base to KPN One and we can support that full base with less people than we do in LE or corporate. Corporate we migrated 73%, but against lower margins. And that's what we are focusing on.

So we have third fiber initiatives in the Netherlands, and that also had to do with the slow rollout of KPN a couple of years ago. We gave them room to maneuver. There's been fiber rollout in rural areas where we didn't roll out, we prioritized in other areas. And so the business case in the Netherlands: a third party rolls out fiber and then you sell to KPN. And this is not the way we would like to do business, but it's important that we speed up our rollout to lock in all the capacity to avoid others to do it. Secondly, our message to these initiatives is: go to Germany, there's more room there to maneuver, there are more rural areas, probably a better business model as well. Because we are now in the lead of rolling out fiber. And so it's not that they all can roll out fiber or we buy it. The consolidation we recently did was a very small one, six thousand lines. For the first time we had to book it in capex because we didn't buy a company, we only bought the access network. So it's really a network we bought, that's it, no people involved or whatsoever. But we know these people from the beginning, so we know where they were rolling out and we didn't roll out there ourselves. There are also areas in the Netherlands where others start and we go in because to protect our customer base and because we have that area on our list as well. Currently we worked out a plan for all municipalities in the Netherlands. So in 295 municipalities in the Netherlands, KPN has a network plan, and currently we are working in 85 regions. So that's big operations in the Netherlands, we're a small country. And I think that will delay and decline the introduction of more parties in the Netherlands. And only when we can do a good deal and only when it fits our network, we consider to buy. There's no overlap in the Netherlands, there's no overlap. And it is very important that we make sure that it will not happen in the Netherlands. So that's why it's again important that we speed up our rollout as well.

Well, before I hand over to Chris, I must say I'm happy with Chris coming in because we improved the way we run our capex and we improved the way we run our working capital. And there's room to improve there, and that's what we currently see. We always said fiber rollout means that we have to pre-finance a lot, but on the other hand, if we are responsible for a fiber chain in the Netherlands with three to five thousand people at work and with all the construction going in 85 areas, we can do better in the negotiations on payment terms than when we only do 100,000 lines per year. So I would say that we improve there, and that's why the impact is less than we mentioned when we presented our fourth quarterly results.