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Telef’onica Accelerates Its Growth and Reaches a Net Income of 2,849 Million Euros Until September

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Telef’onica (NYSE:TEF) (LSE:TDE) presents solid results for the third quarter of 2014, that has led to a net benefit of 2,849 million Euro in the first nine months of the year. The results of the third quarter show an acceleration in year-on-year growth rates both in revenue and in OIBDA, as a result of the sustained commercial momentum in high-value customers and services, that is also reflected in record levels of quarterly net additions in smartphones and fibre.

In the first nine months of the year, revenue reached 37,978 million Euro (+1.9% year-on-year organic), and the OIDBA was 12,325 million Euro to September and returned to growth in organic terms (+0.2% year-on-year). In addition, the ongoing efforts to maximise efficiencies, unlock synergies and simplify our operating model enabled us to stabilize OIBDA margin year-on-year erosion and to post a sequential margin expansion (to 32.8% in the third quarter; 32.5% in January-September) despite higher commercial (focused on maintaining revenue growth acceleration) and network (oriented to manage the strong increase in data traffic).

In the report on the presentation of results, the Executive Chairman of Telef’onica, C’esar Alierta, has emphasised the important advances made in the third quarter in Telef’onica’s transformation process and has stated that “the closing of the consolidation activity in Germany and the acquisition of GVT in Brazil bring structural changes in the positioning of the company in two of its principle markets and reinforces the capacity for future growth”. At the same time, he has emphasised the investment effort being made by Telef’onica in the modernisation of infrastructure and the difference in quality of the services provided, also like key aspects to guarantee sustainable growth.

Lastly, Telef’onica has reiterated all of its operational targets set for 2014, such as the dividend promised in its shareholder remuneration policy.

Leader in high value added customers and services

Telef’onica’s total accesses stood at 316.1 million at the end of September 2014, up 2% year-on-year in organic terms (excluding the accesses of T. Czech Republic and T. Ireland from the basis of 2013, following their disposal in January and July 2014, respectively), driven by the sustained growth of higher value and quality segments such as mobile contract (smartphones and LTE), fibre and pay TV, which maintained a high level of commercial activity in the quarter.

Mobile accesses totalled 249.4 million, up 2% in organic terms compared with September 2013. Mobile contract accesses grew at a faster pace (+8% year-on-year in organic terms) and now account for 36% of mobile accesses (+1 percentage point year-on-year). As a result of the Company’s strategic focus on growing data services, smartphones (all with a data plan attached) stood at 82.3 million, up 43% year-on-year in organic terms (+5 percentage points compared with June), reaching a penetration rate of 35% over total access base. Organic quarterly net additions reached 8.5 million accesses boosted by Telef’onica Brasil, with 5.8 million net additions, almost 3 times the figure posted in the same period of the last year. Organic net additions in the first nine months totalled 19.3 million (+28% year-on-year).

Retail fixed broadband accesses totalled 17.7 million (+1% year-on-year organic) posting a sustained figure of 52 thousand net additions in the quarter in organic terms. Fibre accesses stood at 1.4 million at September 2014, 2.1 times vs. September 2013, after posting record net additions in the quarter of 265 thousand accesses (206 thousand accesses in the second quarter) boosted by T. Espa~na (208 thousand accesses).

Pay TV accesses totalled 4.6 million, with growth accelerating for the sixth consecutive quarter to 41% in organic terms on the back of 458 thousand net additions in the quarter, 4 times the figure in

July-September 2013. This acceleration in commercial activity was primarily driven by Telef’onica Espa~na, which posted net quarterly additions of 370 thousand accesses. Net additions in organic terms in the first nine months totalled 1.1 million accesses (over 10 times greater year-on-year). Also noteworthy were the performances of T. Brasil and T. Hispanoam’erica, both posting double-digit year-on-year growth in their customer bases.

Analysis of Profit and Loss account

In the first nine months of 2014, the year-on-year evolution of exchange rates negatively impacted financial results, in particular the depreciation of the Argentine peso, the implicit devaluation of the Venezuelan bolivar following the introduction of the new exchange rate mechanism (SICAD I), along with the depreciation of the Brazilian real. Thus, in the January-September period exchange rates reduced both year-on-year revenue and OIBDA growth by 9.3 percentage points. On the other hand, the results of Telef’onica Czech Republic and Telef’onica Ireland were deconsolidated from January 2014 and July 2014, respectively, as a result of the disposal of both companies, therefore affecting the year-on-year comparison of Telef’onica’s reported financial results. Thus, in January-September changes in the perimeter of consolidation reduced year-on-year revenue growth by 3.4 percentage points and year-on-year OIBDA growth by 4 percentage points.

Revenues totalled 37,978 million euros in January-September 2014 (13,021 million euros in the third quarter), up 1.9% year-on-year in organic terms, with growth accelerating to 2.8% year-on-year in the third quarter. The improvement in revenue growth was driven by T. Hispanoam’erica, which continued to post double-digit growth, and by mobile data and digital services revenues, with improving contribution from T. Espa~na and T. Deutschland (+0.6 percentage points and +0.3 percentage points, respectively, compared with the second quarter). Excluding the negative impact of regulation, revenues in organic terms grew 3.6% year-on-year both in the third quarter and in January-September 2014.

Operating expenses in January-September totalled 26,486 million euros, up by 2.7% year-on-year in organic terms (-9.6% reported) and by 5% in the quarter (-4.8% reported) despite the savings resulting from the transformation of the operating model and Telef’onica’s scale, due to higher commercial and network and systems costs.

Gains on sales of fixed assets totalled 119 million euros in the first nine months of 2014 (61 million euros in the third quarter), mainly associated with the sale of non-strategic towers and the reporting of a profit associated with the asset disposal of the United Kingdom fixed business once all the conditions set out in the sale agreement had been satisfied.

Operating income before depreciation and amortisation (OIBDA) in the first nine months amounted to 12,325 million euros (4,269 million euros), up slightly year-on-year in organic terms (+0.2%). Organic growth accelerated in the third quarter to 0.8% year-on-year driven by better sales momentum and despite the higher commercial efforts. In the quarter, especially noteworthy were the double-digit growth posted by T. Hispanoam’erica (+15.1% underpinned by the acceleration in Mexico, Colombia and Per’u), the growing contribution of T. Brasil (+0.2 percentage points quarter-on-quarter) and the lower negative contribution from T. Espa~na (+0.6 percentage points compared with the second quarter). Excluding the negative impact of regulation, organic OIBDA growth stood at 1.5% in the first nine months and 1.6% in the quarter. OIBDA margin stood at 32.5% in the first nine months of 2014, with limited year-on-year erosion in organic terms (-0.5 percentage points). In the third quarter the margin expanded sequentially 0.4 percentage points to 32.8%.

Operating income (OI) totalled 6,034 million euros in the January-September period, 4.5% higher

year-on-year in organic terms.

Share of profit (loss) of investments accounted for by the equity method amounted to -69 million euros in the first nine months (-9 million euros in July-September), mainly due to losses registered on the Telco, S.p.A. investment in the second quarter.

Net financial expenses amounted to 2,114 million euros in the first nine months of 2014, of which 193 million euros were due to net negative foreign exchange differences primarily as a result of the implicit devaluation of the Venezuelan bolivar against the US dollar. Corporate income tax in January-September 2014 totalled 723 million euros, implying an effective tax rate of 18.8%. Profit attributable to minority interests reduced net income by 279 million euros in the first nine months of 2014 mainly as a result of the revaluation of deferred taxes at Telef’onica Brasil in the second quarter.

As a result, consolidated net income in the first nine months of 2014 amounted to 2,849 million euros (947 million euros in July-September), down 9.4% year-on-year (-13.0% in the third quarter). Basic earnings per share amounted to 0.61 euros (-12.9% year-on-year) and to 0.20 euros in the third quarter (-16.6% year-on-year).

Greater investment effort in order to guarantee sustainable growth

In the third quarter, the Company remained focused on technological transformation and network modernisation, with over 73% of total investment in the year devoted to transformation and growth. As a result, CapEx grew 26.2% year-on-year in organic terms in the first nine months (+24.6% year-on-year in July-September) and totalled 5,738 million euros, including 192 million euros relating to spectrum acquisition (in Colombia and Central America in the first quarter).

Operating cash flow (OIBDA-CapEx) totalled 6,587 million euros in the first nine months.

Solid financial situation

Free cash flow amounted to 2,839 million euros in the first nine months. Net financial debt stood at 41,200 million euros at the end of September 2014, down 4,181 million euros year-on-year and 2,591 million euros lower quarter-on-quarter. Including post-closing events (related to the acquisition of E-Plus, the sale of 2.5% of the stake in China Unicom and the sale of the remaining 4.9% stake in O2 Czech Republic along with the changes to the Licence Agreement of the brand O2), net debt stood at 44,879 million euros.

The leverage ratio (net debt over OIBDA) for the last 12 months stood at 2.39 times and at 2.52 times including post-closing events mentioned above.

In the first nine months of 2014, Telef’onica’s financing activity through capital markets stood at around 13,900 million equivalent euros. This activity was mainly focused on completing the financing for the acquisition of E-Plus (via the issue of a 1,500 million euro bond mandatorily convertible into Telef’onica shares and the execution of T. Deutschland capital increase), strengthening the liquidity position, actively managing the cost of debt and smoothing the debt maturity profile of Telef’onica S.A. for the following years.

Digital Services

Third-quarter highlights in the area of the Chief Commercial Digital Officer (CCDO) include the following: In Consumer, revenue of the Video business amounted to 717 million euros in the first nine months of the 2014. Year-on-year growth in organic terms accelerated for the third quarter in a row. In the Corporate (B2B) area, M2M revenues stood at 146 million euros in the first nine months of the year (+44% year-on-year in organic terms), fostered by the growth of M2M accesses. On the other hand, revenues from the Cloud business grew by 31% year-on-year in organic terms to reach 241 million euros. Lastly, in the Information Security area, revenues in the first nine months of 2014 stood at 75 million euros, with a year-on-year growth of 42% organic.

Telef’onica Global Resources

Telef’onica Global Resources continued to drive the Company’s technological transformation, with the benefits in investments and efficiency initiatives to modernise and transform the networks and systems now becoming visible, enabling the Company to differentiate its propositions in key markets.

The Global Network and Operations unit stepped up the UBB rollout, reaching 12.5 million premises passed with fibre at the end of September (around 2 times more than in September 2013), surpassing 16,500 base stations with LTE (2.5 times more year-on-year). 4G coverage in Europe stands at 54%, while availability is steadily growing in Latin America, with 8 countries now in service.

Network modernisation and the benefits of scale enabled the Company to execute several initiatives around simplification, process homogenisation (processes and tools) and standardisation (requirements and specifications) that helped to improve operational efficiency.

Finally, the global IT area uses technology as a transformation driver to achieve better levels of efficiency, service and customer relationship and promotes projects focused on automation, standardisation, recycle and modernisation to enhance agility and efficiency. As an example, it should be highlighted projects related to digital capabilities and customer experience: the new online convergent customer channel in Spain or the launch of the first virtual assistant for Vivo customers.

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