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Executives

Hans Söhngen - Head of Investor Relations

Eelco Blok - Chairman of Management Board and Chief Executive Officer

Steven Van Schilfgaarde - Interim Chief Financial Officer

Joost F. E. Farwerck - Member of Board of Management and Managing Director of KPN Netherlands

Analysts

Roman Arbuzov - Barclays Capital, Research Division

Akhil Dattani - JP Morgan Chase & Co, Research Division

Simon Weeden - Citigroup Inc, Research Division

Paul Sidney - Crédit Suisse AG, Research Division

Timothy Boddy - Goldman Sachs Group Inc., Research Division

Ulrich Rathe - Jefferies LLC, Research Division

Sasu-Petri Ristimaki - BofA Merrill Lynch, Research Division

Koninklijke KPN N.V. (OTCPK:KKPNY) Q2 2014 Earnings Call July 30, 2014 9:00 AM ET

Hans Söhngen

All right. Good afternoon, everyone. Welcome to KPN's Second Quarter 2014 Results Presentation. Let me briefly point out that the Safe Harbor statement applies to this presentation, and that any forward-looking statements made in this presentation do not differ from those already made in the press release published this morning.

I would now like to turn hand over to Eelco Blok, CEO of KPN.

Eelco Blok

And good afternoon, everyone. Thank you for joining us at the presentation of our second quarter results. With me today are Steven Van Schilfgaarde, our interim CFO; and Joost Farwerck, Managing Director of The Netherlands.

Before I go through the strategic and operational progress we are making, I would just remind you of the impending changes to our management structure. We announced last week that Jan Kees de Jager will start at KPN in August and take over as CFO at the start of November.

Jan Kees brings extensive financial experience and operational leadership in the technology sector. I'm very pleased he is joining the KPN management board. That means that Steven will step down in November after this transition with Jan Kees. Steven has been a tremendous help to us by stepping up into the interim CFO role.

It was announced 4 weeks ago that Thorsten Dirks will become the CEO of Telefónica Deutschland on completion of the sale of E-Plus. Thorsten has been my board colleague since 2011. KPN and I personally owe him many things -- thanks for his achievements and leadership in recent years. We wish him the very best of success in his new role.

As a result of the sale of E-Plus, we will realign and simplify the management structure. We are giving Joost Farwerck the new board role of Chief Operating Officer, with main responsibility for networks and operations. Furthermore, we are creating the board position of Chief Commercial Officer to take leadership for our commercial activities in consumer and business markets. I will fill in that position at interim until we make an appointment.

I'm confident that the new management structure enables us a functional and more direct control of our operating activities. And this will lead to an even stronger customer focus and cost control.

Let me now run through the key points of the second quarter. On the 2nd of July, the European Commission conditionally cleared the sale of E-Plus to Telefónica Deutschland. We are confident that the sale of E-Plus will be completed in the third quarter. The sale is a milestone for KPN. It will leave us more focused and with the financial resources we need to continue to successfully execute our strategies in The Netherlands and in Belgium. It also allows us to recommence dividend payments to our shareholders. Finally, please note that as the result of the EC approval, the deferred tax asset related to the sale of E-Plus has now increased by some EUR 200 million to EUR 1.1 billion, and will support free cash flow in the coming years.

We've continued to make good progress with the execution of our strategy in the second quarter. That success can be seen in high postpaid net adds in Consumer Mobile, continued good IPTV net adds and growing 4G and multi-play customers in our Consumer and Business segments.

The size of the Dutch business market continued to decline due to customer rationalization and optimization. Next to our focus on new revenue streams, we've started to accelerate the Simplification program in the Business segment to adjust the organization to the new market environment and to lower the cost base.

BASE company and E-Plus once again, showed further improvements in service revenue and outperformed the market. Financially, our performance from continuing operations in the second quarter was impacted by lower year-on-year price levels as the result of the competitive environment in our mobile markets and, as I said, pressure on the size of the business market. Despite this, our income statement for the second quarter shows slightly improving year-on-year trends compared to the first quarter. The benefits of the Simplification program are starting to emerge in the cost base with around EUR 75 million savings realized already. So far, in 2014, we reduced headcount by about 350 FTEs under the new program, which has a target of 1,500 to 2,000 by 2016. So there's more to come.

The execution of the Simplification program will further support CapEx and OpEx reductions in the second half of 2014 and beyond. Our free cash flow in the first half of 2014 reflects intra-year phasing. You will hear more about that later from Steven.

This slide shows the fundamentals that underpin our strategy as presented at the Capital Markets Day in February. Today, we will summarize the progress we are making on all of these. On closing of the sale of E-Plus, we will receive EUR 5 billion in cash, partly from Telefónica Deutschland and partly from Telefónica. That will leave us with a lower financial leverage than in the past, and allows us to start paying dividends again.

We will use the majority of the proceeds to increase financial flexibility, including reducing gross debt to improve the efficiency of our balance sheet. We will remain -- we will maintain sufficient flexibility to support our strategy. Final decisions will be made following closing of the transaction, but all options we are considering should be shareholder value accretive.

Although, we much regret losing Thorsten, we will keep benefiting from his skills, while we remain a shareholder of Telefónica Deutschland. The 20.5% holding will give us further financial flexibility, exposure to the strong synergies of the combination and the potential to receive dividends. Also with respect to the 20.5% stake in Telefónica Deutschland, I would like to state that any future decisions will only be taken with a view to creating shareholder value.

The hybrid upgraded copper/fiber strategy we have pursued in the last years is delivering great progress. We are on track to acquire full control of the Fiber-to-the-Home joint venture Reggefiber. By the end of this year, we will have 3/4 of The Netherlands at speeds of 40 megabits per second or more. Also, by accelerating the rollout of vectoring in the second half of the year, over 1/2 of the Dutch households will have access to 100 megabits per second at the end of 2014.

We completed the rollout of 4G in The Netherlands in the first quarter, just 15 months following the spectrum auction. We have already reached 1.4 million 4G subscribers in the second quarter and we are leveraging that first-mover advantage into fixed mobile combinations.

The strong focus on high-quality services through best-in-class networks and market-leading products such as 4G, IPTV and cloud services is strongly supporting the uptake of multi-play by consumers as well as businesses, which, in turn, significantly reduces churn. And in Belgium, the combination of high network quality and price leadership is supporting our continued good operational performance.

The Netherlands today has a strong and dynamic competitive landscape in both fixed and mobile. We've proven that bundling services in the consumer residential markets strongly reduces churn. We believe that convergence of fixed and mobile services will be an ever-growing factor in the future. As the only true integrated access provider in The Netherlands, with our own fixed and mobile networks, we can fully leverage these assets to meet customer demand for convergence and high-quality networks.

Last year, we introduced our quad play offering for the KPN brand, which has already resulted in good customer uptake. Recently, we also started to broaden our range of converts offerings by introducing new consumer fixed mobile bundles for our KPN and Telfort brands, which combined a mobile subscription with 1 or 2 fixed services.

We told you earlier this year, how we expect our CapEx levels to fall in the coming years. And we also set out the targets for the Simplification program. We are very much on track on both fronts with around EUR 75 million savings from the Simplification program in the first half of 2014. Steven and Joost will say more on CapEx and Simplification later on.

In Belgium, our clear market position that combines a high quality of networks and services with price leadership puts us in exactly the right position to stay successful as a mobile challenger and deliver continued market outperformance. This is evidenced by consecutive quarters of good postpaid net adds and growing market share.

We continue to make good, strategic and operational progress. And on that basis, we are on track for stabilizing financial performance towards the end of 2014 and free cash flow growth in 2015.

We are conscious of and grateful for the support we've had from our shareholders in the recent years, and are pleased to be able to restart dividend payments. The EUR 0.07 dividend in respect of 2014 is at a sustainable level, and we intent to grow this in respect of 2015. Shortly after the closing of the E-Plus sale, we plan to pay the 2014 interim dividend and we will inform you about the details once the E-Plus sale is completed.

Now I will hand over to Steven for the financial review. Steven?

Steven Van Schilfgaarde

Thank you, Eelco. Good afternoon, everyone. I will start with the financial profile of the group. In the second quarter, our pro forma net debt level increased slightly by about EUR 100 million compared to the end of Q1 2014. This included the expected net cash proceeds of the sale of E-Plus and the expected consolidation impact of Reggefiber.

The increase is mainly related to [indiscernible] payments E-Plus, related to previous years, which are for accounts of KPN. The increase is partly offset by the positive free cash flow in Q2.

At the end of the second quarter, pro forma net debt over EBITDA was around 2.2x, this is slightly higher than in the first quarter due to EUR 133 million lower 12-month rolling EBITDA and EUR 95 million higher net debt. Gross debt decreased by EUR 650 million in the quarter as the result of a bond redemption for that amount.

Moving onto pensions. On the 24th of June, the trade unions approved the implementation of a defined contribution plan for KPN's main pension plan, which covers the majority of KPN's employees in The Netherlands by the 1st of January 2015. As part of the implementation of the new pension plan, KPN will make a one-off lump-sum cash payment of EUR 200 million.

In that respect, there has been a release of provision this quarter of EUR 451 million, EUR 361 million net of tax, which positively impacted the reported EBITDA. Any remaining provisions will be released at the end of this year.

As a result, any accounting risks related to KPN's main pension plan is removed from the balance sheet. This reduces cash flow volatility and also positively impacts the adjusted leverage ratios as used by the current rating agencies.

Let me now take you through our Q2 group results. Adjusted revenues for the second quarter were down 7.0% year-on-year, compared to minus 7.7% in Q1. The EUR 150 million decline was mainly driven by EUR 86 million lower revenues in the Business segment, EUR 35 million lower revenue in Consumer Mobile and EUR 33 million lower revenue in NetCo. The underlying OpEx continued to decrease as a result of execution of our FTE reduction programs.

The adjusted EBITDA, excluding the impact from phasing out of handset lease of EUR 48 million, decreased by 13% year-on-year as a result of lower revenues, again, a slight improvement compared to the minus 15% result in the first quarter. Also related to the P&L, but only affected discontinued operations, is an impairment related to the 20.5% stake in Telefónica Deutschland that we will receive following the sale of E-Plus.

As the conditional decision by the European Commission regarding the sale of E-Plus has been announced, KPN's best estimate of the fair value of this 20.5% stake at the end of Q2 is now based on the share price of Telefónica Deutschland, instead of the implied value at announcement of the transaction. This leads to an impairment of EUR 744 million. The tax book loss related to the sale of E-Plus, increased to EUR 4.6 billion, resulting in a total deferred tax asset of EUR 1.1 billion, an increase of EUR 210 million. This deferred tax assets will limit tax cash out in The Netherlands in the coming years.

Let's skip one slide and move to the group cash flow for Q2. In the second quarter, our free cash flow from continuing operations

[Audio Gap]

euros higher than in Q2 2013. The main items that explain this improvement are EUR 105 million lower CapEx, which I will explain later, EUR 35 million more cash from change in working capital. And EUR 23 million improvement related to other items, such as lower tax payments from continuing operations. This was partly offset by EUR 143 million lower reported EBITDA excluding the pension provision release. This release is a noncash item and therefore, also visible in the line change of -- change in provisions.

The free cash flow from continuing operations for the first 6 months amounted to minus EUR 220 million. The numbers on the slide reflect the usual intra-year phasing. Free cash flow is largely generated in the second half of the year. We expect this to be driven by working capital developments, lower interest in tax payments and the Simplification program. Compared to last year, there is a large difference in working capital timing, as the first half of 2013 was reported by significant prepayments in Q4 2012.

Now let's take a look at our CapEx development. As a result of our investment-led strategy in the last years, we have seen elevated investment levels at KPN compared to our European peers. We now see CapEx coming down and have provided a CapEx outlook of less than EUR 1.4 billion for 2014.

Compared to the first half of 2013, we spent about EUR 200 million less in the Netherlands. This was mainly due to lower customer-driven investments, such as phasing out of handset lease model, which contributes about EUR 100 million, and the use of more cost-efficient hardware and set-top boxes in our residential segment.

Also, the completion of some major investment programs, such as 4G in The Netherlands in Q1 have led to lower network investments. In addition, the Simplification program is already showing the first results in both CapEx and OpEx savings, around EUR 35 million out of the EUR 75 million simplification savings related to CapEx, driven by lower IT spend as part of fixed and mobile network investments.

Now let me hand over to Joost for the review of The Netherlands.

Joost F. E. Farwerck

Thank you, Steven, and good afternoon. I would like to kick off by reviewing the operational results in The Netherlands we are making, and we have been making until today. In Consumer Residential, we are executing a clear strategy based on the increase quality of our networks and products, in particular, our market-leading IPTV proposition. Quarter-over-quarter, we are growing on IPTV in RGUs per households.

In residential market, we find ourselves in a competitive, though, rational markets. Competition continues to be active with promotions upon which we have to balance our market shares with profitability.

In mobile, our propositions are now really gaining traction and after all the things we've done in the last years supported by 4G, multi-play and improved positioning of our brands. Including the business market, we now have about 1.4 million 4G customers, which is an increase of 34% versus the first quarter.

In The Netherlands, the size of the business market continues to decline. However, we maintained our strong market position. Going forward, we will further strengthen our excellent position as the integrated access provider in The Netherlands. We have already taken significant steps with respect to 4G improvements, and our large Simplification program will be a key driver. The operational progress in the network company is also supporting the financial performance in these segments.

Commercially, we've implemented a number of initiatives that support our operational progress. In Consumer Residential, we implemented the series of programs that should lead to an uptake in RGU growth and support our market shares. I will come to this when we get to the residential parts in my presentation.

In mobile, we increased the size of data bundles in consumer and business. And in Consumer Mobile, we have increased the pricing of our low-end SIM-only offerings to further reduce the gap between the higher and lower price segments of the market. In Business, we continue to focus on growing multi-play and new services, and we have accelerated the simplification in this parts of our organization, especially.

We are making good progress with the Simplification program as we realize the first operational results since the start of the program, based on the 3 pillars I presented at our Capital Markets Day in February. As you see on the slides, we are rationalizing our product portfolio across all segments. With the simplification of our portfolio, we create greater clarity for our customers. As supported by a number of quality improvements, we've already seen a reduction of inbound calls and significant increase in Net Promoter Score, more than 20% up.

Finally, the investments in our network quality and quality of services are bearing fruit, leading to a better operational performance at our network organization with, for example, a 30% reduction in downtime and 50% reduction in call ratio for IPTV. Now these, for us, are important KPIs to focus.

In total, we've now realized around EUR 75 million savings through our Simplification program, splitting EUR 30 million CapEx and EUR 40 million OpEx savings. Mainly, coming from less IT spends and FTE reductions. The IT spend reduction is not only driven by a firm prioritization of projects with a focus on simplification and efficiency, but also by running these programs in a more disciplined way and in control of our centralized Simplification offers.

OpEx savings are mainly related to FTE reductions. And in the first half of year, we reduced the number of FTEs by around 350. In the second half of 2014 and onwards, the Simplification program will further support a reduction in CapEx and OpEx.

Let's now look at the numbers of The Netherlands as a whole. In the second quarter, we've seen that our financial performance in The Netherlands continued to be impacted by the competitive mobile markets and declining business market size. And the second quarter very clearly demonstrated the phase we are in. On the one hand, we've seen that our year-on-year financial results were still under pressure as the positive operational trends were not yet able to offset the impact from, for example, declining ARPUs year-on-year. And on the other hand, quarter-on-quarter our EBITDA grew slightly and we clearly see positive operational progress with KPI trends developing in the right direction.

For example, Consumer Mobile is showing high postpaid net adds and ARPU is now stable for 3 quarters at EUR 28. Whereas, this was still down EUR 4 year-on-year. So as Eelco already said, the operational progress shows that we remain on track for stabilizing financial performance towards the end of 2014.

KPN has shown good operational trends in both fixed and mobile for several quarters, supported by investments in our networks, our products and customers. And our traditional fixed triple play offering continued to gain traction, and penetration increased by 5% -- points year-on-year.

New the next step after bundling services and fixed has been bundling fixed and mobile services, where KPN's good position is the only integrated access provider in The Netherlands.

Next to our quad play products, we introduced another type of fixed mobile bundles. And these are bundles with at least one fixed product and one mobile subscription. We have launched these offers by Telfort in the second quarter and also this month in our main KPN brands. The key is that the fixed mobile offers revolve around the additional benefits to our customers. Customers respond positively to these offers evidenced by the uptake and the high NPS score on KPN Compleet.

By combining fixed and mobile, we are seeing a reduction in churn in both fixed and mobile. In the second quarter, the number of fixed mobile bundles kept growing to 285,000, of which 273,000 were quad play customers, mainly KPN Compleet. And in addition, the percentage of the mobile postpaid customers having a subscription as part of a fixed mobile bundle increased to 11% from 2% a year ago.

In Consumer Residential, we have seen a continued level of promotional activities by the competition. Their actions were mainly focused on growth via increased marketing and sales, free hardware and promotional triple play pricing. Coupled with the ongoing decline of traditional voice services, top line was somewhat impacted in the second quarter with adjusted revenues 0.8% lower year-on-year.

Also in the second quarter, we remained disciplined in the market with a strong focus on growing IPTV. This is leading to an increased profitability with adjusted EBITDA increasing by 19% year-on-year.

Interactive TV continued to grow, which has led to 2 million TV customers at the end of the second quarter. As I already mentioned, we've implemented several initiatives to support further growth in IPTV, and to get back to growth in broadbands. And these include the following: A new simple integrated Fiber-to-the-Home and copper line that was introduced this month. We are now in the second phase with Fiber-to-the-Home and we will connect all new customers in Fiber-to-the-Home areas to fiber, no longer differentiating between Fiber-to-the-Home and copper except for the premium speeds. The first results are promising and with clear upsell opportunities to premium bundles.

We've introduced new KPN and Telfort fixed mobile bundles. We are accelerating the rollout of vectoring and 50% of the households will have access to speeds of 100 megabits per second by the end of this year. And when necessary, we are swapping hardware to allow customers access to new and unique IPTV futures we offer to our customers.

These and other initiatives should support better IPTV and broadband trends and market share. We will continue to focus on balancing revenues, EBITDA and market shares in the residential markets. The actions taken should further improve this balance.

Now let's move to mobile. Underlying service revenues at Consumer Mobile declined 9.3% compared to minus 12% in the first quarter. Service revenues continued to be impacted by the shift to SIM-only, lower above bundle usage and lower pricing compared to last year. Our mobile market share in The Netherlands was 43% at the end of the second quarter, stable compared to the last 2 quarters. Adjusted EBITDA was EUR 86 million lower year-on-year, largely driven by the phasing out of the handset lease and lower service revenues, but also driven by an increase in subscriber acquisition costs as a result of our high net adds.

We managed to get very good commercial traction with our propositions, which led to high postpaid retail net adds of 53,000 in the second quarter. And we are convinced that we are now in a strong competitive position supported by 4G, new fixed mobile bundles, improved brand positioning and stopping the handset lease model at all our brands.

Finally, we've seen a stabilization of postpaid retail ARPU around EUR 28 in the last quarters, as the continued trend towards no frill and SIM-only was offset by an improved performance of the higher end KPN brands.

When I consider the Dutch business market, I see that KPN has maintained its strong positions in a declining market size. That being said, we can adjust our operating model to retain margin in a value market. And therefore, we focus on a number of elements that should support the top line and increase our costs focus further.

Our 4G customer base grew towards over 0.5 million customers, representing nearly 1/3 of our mobile base in the business markets. And we consider this an important metric, as 4G customers have ARPU upside due to increased data usage and are more loyal. Thereby, reducing churn. The number of multi-play seats grew by 22%, thereby, increasing multi-play revenues.

And on the cost side, we decided to accelerate the simplification in this part of our organization, which will lead to FTE reductions and less spent, in general, in our business segments.

Furthermore, we are focused on simplifying our product lineup. As I've mentioned, more than 40% of the total number of propositions will be reduced this year in business markets. Also, as part of the Simplification, we will focus on optimizing supplier contracts. We're in the middle of that. We look at both the top 50 suppliers and the long-tail suppliers across our telco and IT activities. And I'm convinced that we are implementing and executing on the right areas to improve the performance in the Business segment going forward.

In terms of financial performance, we have seen the continuation of the trends we've seen in the first quarter with a somewhat better EBITDA margin in business. The number of access line reduced, driven by customers optimizing their demands. And on the other hand, the wireless base increased by 60,000 in the second quarter as the take-up of multi-play continued.

So to conclude for The Netherlands, we've made good operational progress across all segments and implemented several initiatives to further strengthen our position as the integrated access provider. We are ahead of the curve with our upgraded networks and market-leading products. And I'm really pleased with the progress we are making on the execution of the simplification of The Netherlands, which is on track and already delivering first benefits. The continued execution will be one of my key focus areas in the coming period.

I will now hand over to Eelco for the operating review of Germany and Belgium.

Eelco Blok

Thank you, Joost. Although we are nearing the end of the sale process, we've been able to continue the good performance of E-Plus. Also, in the second quarter, we have outperformed the market. Underlying service revenues increased by 5.3% year-on-year, growing our market share to over 16%. The continued improvement is mainly driven by growing postpaid service revenues and stabilization of prepaid. Also, the EBITDA margin was higher year-on-year at 32.4% as a result of strong cost focus. The 89,000 postpaid net adds show a continued good operational performance, although somewhat lower than previous quarters.

Let's move to Belgium. Here, we've seen continued good operational developments in the second quarter, although the market remained competitive with competitors launching new propositions. The underlying service revenue declined, continued to improve to 1.9% in the second quarter. This was driven by the good performance of postpaid, as data usage and data revenues are growing while prepaid remained under pressure.

As the result of the market outperformance, we estimate a year-on-year increase of the market share to around 21% in the second quarter. The adjusted EBITDA margin was impacted by higher traffic costs as the result of the flat fee propositions and the provision related to the Walloon site taxes.

In the second quarter, we saw continued good postpaid net adds of 16,000 driven by a combination of high-quality networks and services at attractively priced propositions. Postpaid and prepaid ARPU remained relatively stable Q-on-Q. BASE company continued to make good progress with the rollout of its 4G network now reaching approximately 55% outdoor coverage of the Belgian population including Brussels.

Let's now move to my concluding remarks. We continued to make good strategic progress driven by our market-leading products and best-in-class networks. Our unique multi-play propositions, supported by our excellent position as the integrated access provider, are clearly showing results as churn significantly reduces.

Conscious of market development in our fixed and mobile markets, we will continue to carefully balance revenue, EBITDA and market share going forward. This is evidenced by the high postpaid net adds in Consumer Mobile in the first half of 2014 and initiatives that have been implemented to support our market shares in Consumer Residential in the second half of the year.

In Belgium, our high-quality network combined with price leadership puts us in exactly the right position to stay successful as a mobile challenger. The sale of E-Plus will create a solid financial profile for the KPN Group and allows us to start paying a dividend again. With the good strategic progress we are making and the execution of the Simplification program beginning to demonstrate positive results, we remain firmly on track to show stabilizing financial performance towards the end of the year.

Thank you. And now we're happy to take your questions.

Question-and-Answer Session

Unknown Analyst

[indiscernible] UBS. Just have 3 different questions. The first one is just in terms of the portfolio. If you look at your 20.5% stake in Telefónica Deutschland and if you look at BASE in Belgium, are these core to KPN longer-term? Would you consider divesting them and returning cash to shoulders? The next 3 questions are probably for Joost in terms of if you look at Consumer Mobile, if we look over the coming quarters, can we expect postpaid ARPU to remain [indiscernible] stable at 28? And also, if you look at the momentum that you've been seeing in terms of net adds, can this accelerating momentum continue? And where are the net adds coming from? Is it from any particular player? And actually, the second question is for you guys is just in terms of pricing. You mentioned that pricing for the SIM-only offers, you're actually increasing the prices. So you'd just talk through that in the context of Tele2 launching 4G at some point later in the year, isn't that a strange move to actually increase your prices, ahead of a new entrant coming in?

Eelco Blok

I will start with the portfolio question. Starting with the 20.5% stake in Telefónica Deutschland, as you know, we are in the -- well, final phase of the process of closing the transaction. And we don't know today all the details we need to take a decision on our next step with the 20.5% stake, but I can assure you that we will do everything to take the right decision to create as much as possible shareholder value as we can. And as I've said, we still have to wait until we have all the information needed to take this decision. That's on the 20.5% stake in Telefónica Deutschland. On BASE, it's a subsidiary that is really performing well, outperforming the market. We see also some upside in the financials going forward, but we are pragmatic, meaning that if somebody knocks on our door and presents an offer to us that is attractive also from a shareholder perspective, then we will do exactly the same as we have been doing with E-Plus. And Joost will take the 2 questions on Consumer Mobile and pricing.

Joost F. E. Farwerck

Yes, as you know, our consumer market is competitive. That's what we concluded on 2 years ago. So we really invested first in the most important things as the network and we decided to roll out 4G as fast as we can. So we ended up ahead of competition on 4G. We really worked on our propositions. On all the brands, we made it simpler. The better overview for our customers to choose, and the price points are very important. And then what you see is that the net adds come in. So last quarter was okay. This quarter is better and we're working on these trends. It's not that you lose it from one day to the other, you really have to work for it. And so, I expect this trend to go forward on net adds. And it's fairly important that you look at the health of the net adds. So -- and that's what we do. We look at the high-value brands compared to the no-frill segments. And I think it's very important in the markets, as being the market leader, to make choices to run the most profitable base. And that's why we decided to increase tariffs in the no-frills SIM-only brands because we would like to have our high-value brands in the base. And we see good ARPU in flow, and that's very important to KPN. You look at the average and you look at the inflow. And when it's above, then you do the right thing. So that's where we are. And like I say, it's a machinery. So it's not going to this disappear from one day to the other, but it's fairly important that you run it in the right direction, invest in right net adds, and then we continue to do this quarter after quarter. So we just more or less started this, and I expect them to deliver more net adds in the coming quarters. And on ARPU, stable for a couple of quarters now. I can't predict it that will be like that, but I will work very hard to make it happen and that's why, like I just said, it's important to increase on the lower side and move your customer base to the high-end customers. You mentioned that, too, it's a competitive market like I said, but the good news for me was that also, the other high-value player in the Dutch market showed net adds. So there is a market for high-value net adds, especially when you are on 4G. So as a market leader, we have to understand that and direct ourselves in the first place to that route. And Tele2, you mentioned, they are rolling out 4G. We are not sure where they are. Now they are an MVNO and they -- yes, they do less net adds, I think, during its coming in, but it's up to Tele2 to explain how they run their business. But we follow that, of course, also very carefully.

Roman Arbuzov - Barclays Capital, Research Division

Roman Arbuzov here from Barclays. A couple of questions, please. On mobile, and actually starting with multi-play. You're saying that you're now going to offer multi-play with single-play fixed products and double play. Can you please just explain a little bit how exactly that's going to work? Are you going to double mobile allowances as you are currently doing with triple play? And yes, a little bit more color on that, that I'll be great. And on FttH and copper, no longer making a distinction, could you please talk about pricing, does that mean FttH prices have come down or copper prices have come up? And also a question on your discontinued operations. Perhaps you can give a little bit of color on why the German margins were very high in the quarter?

Joost F. E. Farwerck

It was very difficult for me to understand...

Unknown Executive

Yes, the last question?

Roman Arbuzov - Barclays Capital, Research Division

The Germany margins, why were they so high in the quarter?

Eelco Blok

And I will start with the last question about the German margins. That's just driven by the decision to balance postpaid net add growth and EBITDA and continued strong cost focus. Joost?

Joost F. E. Farwerck

And your first question, I didn't get completely. I think you referred to our fixed mobile combination.

Roman Arbuzov - Barclays Capital, Research Division

Yes, the fixed mobile offers. I currently understand the way it works now with the triple play is that you basically double the minutes, SMS and data allowance with the triple play plus you give away some additional channels on the fixed side. How is that going to work if it's a double play or a single-play customer? Does it work exactly the same way or will there be a pricing element for example...

Joost F. E. Farwerck

No, so on triple play, we decided when a customer moves to quad play, which we call KPN Compleet, we don't offer discounts. We offer more services on a more or less fixed cost base. So that's free calling in the family, more data on the mobile and more TV channels on the iTV. On fixed mobile, so the dual play what we call multi-play in the presentation, we make a price package for the combination of the fixed and mobile minutes. And also there, it's benefiting the combination of the 2, but we are not heavy in the discounts on the dual play. Now you had a question on Fiber-to-the-Home and on the new lineup and if this means that we will lower tariffs on Fiber-to-the-Home. What we did in -- until today or last month in fiber areas, customers could still choose between a fiber or a copper connection. Now we stopped that and we made it more simple. We made one lineup, which is called -- you can -- there are 3 choices: step in a basic package or a premium package. Now if you are on fiber in a fiber area, you pay EUR 7.50 more for a 100 megabit connection, or EUR 17.50 for a 500 megabit connection. And that's ending up to the ARPU we want to have in fiber. So it's not leading to a lower ARPU in fiber. It's very important in our fiber case that we run a better ARPU. This is one of the key drivers in the fiber area business model. So I think that we will have more fiber customers with this lineup on a high ARPU.

Akhil Dattani - JP Morgan Chase & Co, Research Division

Akhil from JPMorgan. Three questions, please. Firstly, just a question on your fixed, on infrastructure strategy. You've seemingly accelerated your vectoring plans, given the early uptake that you've seen through that. Could you just explain to us what that might potentially mean for a regular fiber rollout? Is there a bit of an opportunity to save further for further slowing the rollout there, or is this something you want to continue at the same pace you highlighted at the full year results? And just what that might potentially mean for CapEx? Secondly, on the earnings trajectory over the course of this year, you're sounding a lot more confident on the Consumer Mobile space. Can you just walk us through, in addition to the revenue trend changes that we might see going forward, how we might think about the cost saving phasing from H1 to H2? Is there a bigger weight of savings as we move forward? And again, what could that potentially mean? And then finally, just, I guess, as a follow up to one of the earlier questions we had around portfolio management. I'm just being interested to get an update on your thoughts around Tele2. Obviously, it's something that's debated a lot in the market. In terms of whether KPN strategically would have interest in that asset? Just if you could update us around how you think about that, both in terms of the rationale, but also from a regulatory standpoint, if there are any key data points or timing issues we need to think about before you can even, even consider that as an option?

Eelco Blok

Joost, so you first take the fixed line question.

Joost F. E. Farwerck

Yes, so we are very enthusiastic on the developments on the copper technologies, especially since we have a high-quality copper network with double-twisted pairs to our households. And we rolled out, as you are aware, the new technologies -- pair bonding, vectoring. Now we are now connecting households in a pilot and we are very enthusiastic of what we see over there. So we have a hybrid access strategy that means that wherever we can, we will use the copper network to deliver the speeds to our residential customers. In very weak areas, we will still make use of the Fiber-to-the-Home. And so if we look at the investment pattern of the coming 18 months, my first priority is to invest in VDSL and vectoring since I cover main parts of The Netherlands in a very efficient way. Of course, fiber will deliver at a higher-speed at the end, but fast-moving is the domination of the vectoring and VDSL and pair bonding. So that's what we aim for. We also have to run the budgets and the spend we do. So if I look at the coming year, then I think we will roll out lower on the Fiber-to-the-Home and first make use of the benefits of the investments in copper. Having said that, of course, we will also very much focus on existing fiber areas to upgrade the penetration there. And yes, you had another question on Consumer Mobile? No, you referred to cost savings?

Akhil Dattani - JP Morgan Chase & Co, Research Division

The question was just related group level, it sounds like we are at bit of a turning point in terms of the revenue story. And I just wondered whether that is purely the driver of the earnings stabilization you're talking about? Or whether there's any incremental point you want to highlight in terms of H2 versus H1 cost phasings?

Eelco Blok

The stabilization of the financial performance is, of course, partly driven by the improved top line trends, but mainly driven by the Simplification program and cost savings going forward. We are seeing improved trends in Consumer Mobile, as you all experienced. So that's underlying the stabilization. On Consumer Residential, we see clear EBITDA improvement year-over-year and that we are convinced that we can continue this trend, and business trends are stabilizing. And with the decision we have taken to accelerate the Simplification program, we are convinced that we can mitigate continued negative top line decline in the business market. And NetCo, as you can imagine, will benefit from the Simplification program both on the OpEx and CapEx. And the first positive change of trends, we have now seen in the second quarter compared to the first quarter and we are convinced and firmly believe that we will continue this trend in the third and the fourth quarter. And that's underlying the statement I made that we are confident that we will stabilize financial performance towards the end of 2014. Then the question on Tele2. Well, our clear focus also discussing M&A is on value creation. Meaning, looking at the right asset for the right price and strategically, in consolidation, makes a lot of sense. But from a regulatory point of view, yes, it's a hurdle. And that's where we are today and, of course, we know that timing is of the essence, given our strong position of today compared to where Tele2 is.

Simon Weeden - Citigroup Inc, Research Division

It's Simon Weeden from Citigroup. A couple of questions. One is you've mentioned refarming and the introduction of LTE-Advanced in your press release. And I just wondered if you could elaborate on what that's going to look like in terms of a consumer offer? Not asking for your pricing, but just what does LTE-Advanced give you that you wouldn't have had before? And whilst you're on that, I wondered if you could touch on whether Voice over LTE is a feature that you'll be offering with that or if that comes further down the line, and if so when? That was my first question. And the second question is, if I remember rightly, I think you've said in the past, please correct me if I'm wrong, that you felt that the offer -- or the wholesale proposition made by one of your competitors to Telenet in Belgium was a mistake. Could you comment today on whether you think, therefore, that when that comes up again, that or, in general, that wholesale prices should be rising for MVNOs?

Eelco Blok

I've never said that the wholesale with Mobistar was a mistake. I only shared with you that we were also negotiating a wholesale deal with Telenet, and that we stepped out at a certain point in the process because we believed that the prices Telenet was asking were destroying value in the market and not creating value. And yes, the contract will come to an end, but -- yes, I don't know what will happen when we reach that point. And I think, Mobistar could and should have done a better job than they did when they negotiated to deal with Telenet. And it, well, destroyed also a lot of value for the Mobistar shareholders. So that's my position on the wholesale contract in Belgium. And maybe, Joost, you can answer the question on LTE-Advanced?

Joost F. E. Farwerck

Yes. So when we rolled out LTE on the 800 spectrum in The Netherlands. Almost, full coverage of the total country. And now we roll out also on 1,800 in several locations, the most important ones in The Netherlands. And the combination of the 2 will be used as 1 LTE service. We are enthusiastic, of course, we piloted this first and we see high-speed connections in those areas. We are just started to roll out, by the way, but we see very good results there. I can't tell you how the propositions will look like, but I can tell you that speeds are 50 megabits or more already measured on the combination of the 2 frequencies used as one service. And of course, we are also piloting VoLTE. Also, there we are enthusiastic on what we see in our own pilots. High-quality, we experienced. We do that together with our suppliers, and everything is according to plan. Having said that, we have an excellent combination of 4G and voice already today since we have the best 2G and 3G networks in The Netherlands. So on the KPN network, you can have a 4G subscription and making use of our voice networks as well. But of course, we are also working on VoLTE.

Paul Sidney - Crédit Suisse AG, Research Division

It's Paul Sidney from Crédit Suisse. Just a couple of questions, please. Firstly is general question on 4G. A very interesting data point that you can share with us data usage, either how data usage on 4G is evolving versus 3G or how usage on 4G has evolved over the past 12 months? And quite interesting, given that you seem pretty upbeat about the way usage is going. And just -- then the second question, on Consumer Mobile, you increased the amount of data within your bundles from 1st of July on the KPN brand this year, when it seemed as though Q2 in terms of your share of net adds was getting better. It's just really to understand a bit more about what was the rationale behind increasing the data within the KPN bundles?

Eelco Blok

Joost, well, you can go first.

Joost F. E. Farwerck

Yes. Yes, what we see is a real big difference between 3G and 4G users, especially on the KPN and Hi. And on the KPN, it's -- if I'm not mistaken, almost twice as much. And then on Hi, 3.5 more data usage than on the 3G. So we really see when customers move to 4G, you really make use of more data. So that's a very important conclusion. And we think we should encourage our customers, of course, to use more data on 4G. And why did we make the bundles on KPN bigger? I think that's what our customers want. We want to really differentiate our KPN brands and our Hi brand as high-quality brands compared to the other brands in the Dutch markets. And we see good net adds coming in, but we really want to see KPN net adds coming in. And yes, on everything we do, nowadays, we really see that the KPN, the high-quality and the high ARPU brand customers come in, and that's important when we run the net adds. I mean, I can run a lot of no-frills net adds but that's not adding the value we're focusing on. So I'm really focusing on the KPN brand there.

Paul Sidney - Crédit Suisse AG, Research Division

Sorry. Joost, you said -- a quick follow-on from that, is that one of the reasons why you raised so many pricing as well? Is that how we should think about...

Joost F. E. Farwerck

Yes, I think that's it's very important to -- we invested a lot in The Netherlands in frequencies, in networks, in handsets and everything. So we want to make sure that there's also profit at the end of the line. And therefore, we raised the tariffs in the no-frill segments. And I think that the market is responding to that. It's very important to understand that we are a market leader with all the brands we have. And that every now and then, we really should consider the role we have in the markets. And I think, it was very good that we moved the SIM-only brand to Simyo, 1 euro up. And that we moved KPN in a higher data bundle, and then you see your base also moving. That's very important.

Timothy Boddy - Goldman Sachs Group Inc., Research Division

It's Tim Boddy from Goldman. I had a couple of questions. First of all on the Consumer Residential business, any color on -- I guess, 2 two things, one is the mix gross adds between the KPN brand and Telfort. How that's progressing there? Whether that's changed in recent quarters? And related to that, as you've added value to those bundles, how have you done that? And is that essentially an implicit price cut? And then secondly, Telefonica, obviously, has a focus on deleveraging. And I wondered if as a minority in Telefónica Deutschland, you have any protection, whether it be a minimum leverage commitment or something like that makes you feel confident that you can get an attractive dividend from an asset that when it becomes part of Telefonica group, it will actually be significantly deleveraging for Telefonica?

Eelco Blok

We're a 20.5% shareholder in Telefónica Deutschland. And in the shareholder meeting, we can have influence on what they are doing. So in the end it's Telefonica who will decide what to do with the financial framework, leverage and things like that. So that's one of the items we need to know to be able to take a decision on what to do with the 20.5% stake and, of course, the dividend policy will be one of the very important information that we need to be able to take the decision. And we expect that to be known shortly before the sale will be closed.

Eelco Blok

Joost, on residential?

Joost F. E. Farwerck

Yes. And in residential, our triple play base or multi-play base is mainly focusing on the KPN and Telfort, and both brands do quite well. KPN is somewhat more expensive than Telfort in residential. And this offering more on KPN, the combination really offers the double speed, free calling in the family, more TV channels. And in Telfort triple play package is slightly cheaper than KPN with less speed and less TV channels. So that's the main difference. There's a market for both. Especially in the Dutch market, people are very price-sensitive. So we really look at the customer segments and we target for the Telfort segment and the KPN segment. Both do quite well. Now for the coming quarters, we will focus on the base because we really think it's important to show revenue growth and base growth, again, in the third, maybe, fourth quarter. That's why we improved our lineups, not only on fiber and copper combination, but also in the fiber. We made it more simple and we are improving our marketing campaigns for the coming quarter to really see -- yes, us growing in the residential markets. I already mentioned in my presentation that, for us, it's a balancing act. It's not when competition is doing something like giving away free devices or free field engineers or strong discounts that we follow. It's very important for us to have a balancing act between profitability and market share. We think the coming quarter, we will make benefit for the preparations we did. And at the end, we are happy with the 90% year-on-year EBITDA growth and it's also where we keep an eye on. So it's a balancing act between market share, profitability and customer base.

Ulrich Rathe - Jefferies LLC, Research Division

Ulrich Rathe from Jefferies. Two questions. The first one is again on the residential fixed market in The Netherlands. Given that Ziggo is subject to a takeover at the moment, would you consider their current market approach normal? And do you expect a fundamental shift in the commercial situation in the competitive situation post-consolidation, if it happens? That would be my first question. The second question is for Eelco. At the very end of the Q1 presentation, Eelco, you said that the sort of implications of the guidance, which is probably a bit up for interpretation, you said that ultimately it boils down to free cash flow for the year being roughly flat year-on-year, roughly give and take. Is this something based on the current trends you would reiterate apart from EUR 200 million for the pension settlements?

Eelco Blok

Starting with the question on the guidance. No. No change in guidance compared to what I've said during the Q1 presentation. Yes, of course, taking into account, Steven just -- is telling me to reiterate that excluding the EUR 200 million of the pension.

Steven Van Schilfgaarde

The pension EUR 200 million is an exceptional and also described as [indiscernible] in the press release.

Eelco Blok

Joost, will you take the residential question on the behavior of Ziggo?

Joost F. E. Farwerck

Yes. So we see -- saw and experienced a lot of activities from Ziggo. And yes, you asked me, what I expect after the consolidation. And I don't know what to expect and I can't speak for Ziggo. What -- and I think it's -- you can't just keep on giving away Samsung devices for a very long time, field engineers and heavy discounts at the same time. At least, that's what I think. So therefore, I just said for us it's also about profitability and I hope and maybe expect the new owner of Ziggo to think in the same line. So what you sometimes see one quarter, one player in the market is very active in the marketing campaign. The other quarter, another player in the markets, I never experienced 1 player in the market being very aggressive in marketing discounts, et cetera, for 5 quarters in a row to give you just an example. So I expect rational behavior, let's it put it in that way.

Unknown Analyst

[indiscernible] from Deutsche Bank. You've obviously shown some mention [ph] with the growth in the number of bundled customers and they said [ph] it only represents 11% of the postpaid customer base. Can you give us a sense of what percentage you'd like to see in the near future? And is there not an opportunity to be a lot more aggressive with bundling ahead of the Tele2 launch and [indiscernible] entity entering as well?

Joost F. E. Farwerck

We call ourselves the integrated access player in The Netherlands since -- lots of players and all players in the Dutch market claim convergence. We are the only company with both fixed and mobile assets. And so we really can make the combination and the packages. So we are very enthusiastic of what we prepared and what we launched in the market and also on the growth we currently see, both in consumer and the business market. I think it's a very important KPI to focus on since we really see a reduction of churn when customers move in the triple play or quad-play. And the combination of fixed and mobile here is very important. Now other players have to buy the mobile via an MVNO or the fixed on our network. So that's more difficult, and that's where we want to make benefit from. So for the coming quarters, this will be very important for us to grow our base in the combined -- combination of broadband and mobile. And I expect us to be more successful there than the other players you mentioned.

Sasu-Petri Ristimaki - BofA Merrill Lynch, Research Division

It's Sasu Ristimaki from Bank of America. I had 2 questions, really. The first is, I noticed that the ACM has placed your increase in ownership in Reggefiber in Phase 2 review. Do you anticipate this will lead to any significant remedy discussions that would change the structure of the fixed line market in the country? And then secondly, there's already a mention of MVNOs or wholesaling in Belgium. And I noticed that you recently offered a wholesale deal to, I think, FreedomPop. Do you think that's on significantly more attractive rates than what Telenet has from Mobistar? And is there any indication of how do you see MVNOs, FreedomPop or others, in kind of your home market in Netherlands from here on?

Eelco Blok

ACM took the decision to move the Reggefiber merger approval process to a Phase 2 process, meaning that they are doing some additional investigations on this consolidation. But we don't expect major changes to be the outcome of this process. So we are confident that without major changes, ACM will take a positive decision in Phase 2. So we're in the fourth quarter of this year. Then on the MVNO, can you repeat the question because I...

Sasu-Petri Ristimaki - BofA Merrill Lynch, Research Division

In Belgium, does FreedomPop have similar rates as Telenet in your impression, or are they paying more to you in view of your earlier comments? And is this any indication of how you see MVNOs -- or hosting MVNOs in Netherlands?

Eelco Blok

No -- so, first of all, I don't know the details of the MVNO deal you mentioned. And I can assure you that we will not end up in The Netherlands with the same situation as in Belgium.

Hans Söhngen

Time for 1 or 2 more questions, so...

Unknown Analyst

Zhad Shamil [ph] from Money for Life [ph]. I have 3 questions, if I may. Two are credit-related. The first one is, you mentioned increasing financial flexibility after you receive the proceeds from the disposal. But do you have any rating target in mind or any levered -- leverage target in mind? That's my first one. Second question is related to the comment made by Eelco regarding lowering the gross leverage, the gross debt. Does it mean we should expect some bond tenders after the deal is closed? And my final question is more -- a more general question about your current relationship with América Móvil. Just a few comments would be great.

Eelco Blok

The first question about the target, the only thing we shared with market is that we want to continue to have an investment-grade credit rating. And that at this moment, the only thing we want to share with the outside market. So no net debt over EBITDA target because we believe that could limit really our flexibility, if we put a number or range in the market. Yes, one of the use of proceeds is reducing our gross debt. First of all, it's just a normal redemptions of the debt. And yes, we are looking at several other options, but we'll take a decision later this year when the sale is really completed. Relationship with AMX is improving. It was already okay at the beginning of this year, but is improving. Supervisory board members are participating -- continue to participate in the supervisory board meetings in a constructive way, supporting the strategy of the group. And as I explained to you at the beginning of the year, we have restarted some of the operational working groups and we continue to work on those operational working groups, targeting procurement, our bases and technology. And also, the last few months, the relationship improved on the operational side. So first benefits come in, we are -- especially on VDSL and vectoring and bonding much further than América Móvil, and they are using our knowledge, our experience to translate that to their footprint. So improving relationship operationally and continued, well, good relationship with 2 supervisory board members representing América Móvil.

Unknown Analyst

I have 3 questions, please. The first question was just on KPN's view on over-the-top MVNOs. I know, specifically, the logic of keeping WhatsApp, an MVNO deal in Germany, and then again, as the earlier question asked about FreedomPop in Belgium. I was just wondering, if you see any risk of cannibalization there to your voice revenues through Voice over IP or LTE or something like that? The second question was -- I'm just wondering, how long can your EBITDA in the Consumer Residential keep growing double-digit when revenues aren't growing? I mean, does a point come when your SAC has rebased down to a level where you have to grow revenues again to grow EBITDA? If you could just comment on that? And then the third and final question was just on your -- the B2B ARPU, whether that was a surprise to you in terms of the decline that we've seen in the second quarter? And if so, is there something in the economy that's going on that explains it?

Eelco Blok

Joost will take the residential and B2B question, and I will start with the first question about the MVNOs. The MVNO deal with WhatsApp is just a deal in Germany, fitting within the framework we have, well, as E-plus set in the market. And everybody is on top of it because it's WhatsApp. But I can assure you that there are no, well, strange or disruptive parts in the agreement with WhatsApp. And again, on FreedomPop, as I've said, I don't know the details of the agreement, but I'm convinced that this will not be -- this will not put more pressure in the Belgian market and will not have any impact on what's happening in the Dutch market on MVNOs.

Joost F. E. Farwerck

And on your question on residential, you mentioned top line growth being very important, and I agree with you. So that's why I already mentioned that we have a new lineup. We have a cross in upselling in combination with the mobile, we increased tariffs, by the way, beginning of this month. So for 6 month of the second half of this year, we will benefit from higher tariffs, but it's also about running more customers. So that's what we will focus on, and everything is focusing on that. And you mentioned the B2B ARPU, in the Business segment, we see a decline in wireless. And like I said, it's a 1 euro step-down, but there is pressure in the business market in The Netherlands. We have a very strong market position, but the markets on itself is under pressure. And that's because customers are optimizing their customer demand, the contracts, big banks are closing buildings and selling people's home. And that means, less mobiles and pressure on the pricing when they put a tender out in the market. Having said that, also here, it's very important to look at the health of the base. And the prices we put in the markets, also there we are working on the ARPU. So there's a pressure in the business markets. As market on itself, we have a very strong position and we keep a strong position. And we will mainly also benefit from cost reductions to keep our margins up in the business market.

Hans Söhngen

Okay. With this last question, I would like to end this Q&A session. And thank you, all, for coming over for our second quarter results. Also, the ones on the webcast, let us know if you have any further questions. Thank you.

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Source: Koninklijke KPN N.V.'s (KKPNY) CEO Eelco Blok on Q2 2014 Results - Earnings Call Transcript
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