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Edited Transcript of KPN.AS earnings conference call or presentation 24-Jul-19 11:00am GMT

Q2 2019 Koninklijke KPN NV Earnings Call

The Hague Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Koninklijke KPN NV earnings conference call or presentation Wednesday, July 24, 2019 at 11:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Bisera Grubesic

Koninklijke KPN N.V. - Head of IR

* Jan Cornelis De Jager

Koninklijke KPN N.V. - CFO & Member of the Management Board

* Maximo Ibarra

Koninklijke KPN N.V. - Chairman of the Management Board & CEO

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Conference Call Participants

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* Frederic Emile Alfred Boulan

BofA Merrill Lynch, Research Division - Senior Analyst

* Keval Khiroya

Deutsche Bank AG, Research Division - Research Analyst

* Luigi Minerva

HSBC, Research Division - Senior Analyst

* Paul Sidney

Crédit Suisse AG, Research Division - Research Analyst

* Polo Tang

UBS Investment Bank, Research Division - MD & Head of Telecom Research

* Roman Arbuzov

JP Morgan Chase & Co, Research Division - Analyst

* Samuel McHugh

Exane BNP Paribas, Research Division - Analyst of Telecom Operators

* Usman Ghazi

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to KPN's Second Quarter 2019 Earnings Webcast and Conference Call. (Operator Instructions). Please note that this webcast and conference call is being recorded.

I will now turn the conference call over for our host for today's webcast and conference call, Bisera Grubesic, Head of Investor Relations. Go ahead, please.

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Bisera Grubesic, Koninklijke KPN N.V. - Head of IR [2]

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Thank you. Good afternoon, ladies and gentlemen, and welcome to KPN's Second Quarter 2019 Results Presentation. Before turning to the core of the presentation, I would like to draw your attention to the safe harbor statement on Page 2 of the slide deck, which also applies to any statement made during today's presentation. In particular, today -- today's presentation may include forward-looking statements, including the company's expectations with respect to its outlook and ambitions, which were also included in the press release that we published this morning. All such statements are subject to the safe harbor statement.

I would now like to hand over to our CEO, Maximo Ibarra.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [3]

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Thank you, Bisera. Welcome, everyone. Jan Kees and I will take you through a presentation on our second quarter results and the outlook for the full year.

We made good process with the execution of our strategy. Our top line continued to be adversely impacted by ongoing competitive pressure, particularly mobile and by strategic actions in Consumer and Business. We have seen solid results in the accelerated simplification and digitalization of KPN. These delivered net indirect cost savings of EUR 40 million in the second quarter.

We have started the Telfort brand integration and seen strong interest in converged propositions from Telfort customers, leading to strengthened household relationships; customers with either mobile or fixed product with KPN and product with Telfort are now eligible for convergence benefits. This one-off integration of Telfort customers has led to an additional 54,000 converged postpaid customers and 38,000 converged broadband customers during the quarter.

Finally, we connected approximately 40,000 homes year-to-date, as part of our accelerated fiber rollout strategy.

We will discuss all these highlights in more detail during the presentation.

You know our ambition is to deliver organic growth in a sustainable way. To achieve this, we are accelerating the execution of our strategy through 3 strategic pillars. One, the best converged smart infrastructure; second, focus on profitable growth segments; and third, acceleration of simplification and digitalization. We will give an update on these 3 pillars throughout this presentation.

Accelerated fiber rollout strategy. Let's start with our network. We are currently progressing with our accelerated fiber rollout strategy. As I mentioned earlier, we have connected approximately 40,000 homes, fiber as part of our 1 million ambition. And we are currently working in 19 areas simultaneously. We are ramping up capacity, meaning that by the end of the year, we expect to connect 4x as many homes per week compared to our current run rate. This will bring us our 1 million Fiber to the Home households ambition by end of 2021.

The first XGS-PON connection is live in our network, and we are currently testing it with customers. This allows us to deliver speeds of up to 10 gigabit per second and offer our customers the best possible experience.

Furthermore, we are on track to finalize the Fiber-to-the-Cabinet upgrades this year, meaning that we will connect an additional 2,500 street cabinets to fiber, covering 500,000 households in the Netherlands. These copper upgrades will enable significantly improved access speeds for these households.

IP migration is on track. We are making good process -- progress with our ambition to have all our customers on all IP by the end of 2021.

We announced the end of PSTN and ISDN, 1/2 services in the Netherlands this year and remaining ISDN services by the end of next year. Currently, approximately 400,000 lines are left in our legacy portfolio, approximately half of the number at the start of the year. By migrating our customers to this future-proof all-IP portfolio, we are able to simplify our propositions and network architecture, and we are able to shut down a lot of legacy. This will contribute to our ambition of approximately EUR 350 million of indirect cost savings in the coming years.

Now let's turn out to our segments. Our customers continue to reward us for our services with high NPS scores. Consumer NPS of plus 13 was similar to last year. Quarter-on-quarter, the NPS trend was mainly impacted by the phaseout of the Telfort brand as customers were still asked if they would recommend Telfort to others.

In business, NPS remains in positive territories, compared to minus 4 last year. We are improving our delivery chain, reducing time to market and lowering the number of products. This makes us confident that we can further improve B2B customer experience going forward.

In the quarter, we have won several awards and nominations with our business propositions. Our subsidiary, InSpark, was named Microsoft's Global Partner of the Year when it comes to security and compliance. Computable has nominated KPN EEN as Best offer for SME customers.

On the new brand strategy, we can say that it's really taking shape. We are fully focusing on driving growth in convergence with the KPN brand, and we have seen strong interest in converged propositions from Telfort customers, leading to strengthened household relationships. As of the 1st of May, we have closed 29 Telfort shops and the brand's online presence. This has led to lower acquisition, but in mobile, we were able to keep the total postpaid base flat, seeing we no longer accommodate the lower end of the broader market. We see fewer additions here, negatively impacting our broadband base. However, as we'll no longer have fixed propositions at Telfort price levels, we see a positive mix effect in our fixed ARPU.

Brand rationalization also results in simplification of operations and drives cost savings. We need fewer personnel. We are reducing spend on IT systems. And the simplest structure allows us to bring innovation to customers faster.

We saw a solid performance of our fixed mobile convergent propositions in the second quarter. As highlighted earlier, this was partly driven by the integration of Telfort customers, who now take on one of both products with the KPN brand.

Overall, we saw net additions of 41,000 converged households, bringing the total to 1.4 million. This means that now 48% of our broadband customer base take a combination of fixed and mobile services. Sorry, for that. This was not expected to have the mobile phone ringing. And we added more than 100 -- 1,000 converged postpaid customers. As a result, more than 2.2 million postpaid customers also have fixed services from KPN. Convergence penetration among post-paid points -- sorry, among postpaid customers was up 3 percentage points sequentially to 62%, and we grew the number of SIMs per household in the quarter.

We have been very successful in getting existing customers to take on additional services and spend more with us. More and more customers consider it normal to have one single provider for all connectivity, whether fixed or mobile. We also know that this leads to an increasing customer satisfaction. The Net Promoter Score that customers attribute to us is much higher in a converged proposition. In addition, they spend more through fixed services, and they churn even less. So this combination of products, obviously, is attractive from a financial and performance point of view. The customer lifetime value of a converged customer is much higher than that of a single-play customer.

In Q2 2019, our performance in fixed was impacted by the brand strategy. Stopping acquisition on the Telfort brand and price adjustments impacted broadband net adds in Q2 2019. We saw a decrease of 24,000 broadband customers during the quarter. We want to emphasize that our brand strategy is well-considered strategic decision.

The fixed ARPU increased 6% year-on-year. This is mainly driven by 4 elements: fixed price adjustments introduced 1st of July, 2018; fixed price adjustments introduced the 1st of June, 2019, this is 1 month earlier than in 2018; a higher inflow ARPU as a consequence of integrating the Telfort brand; and a declining legacy base for our fixed voice and DBBT customers who have a below average ARPU. Together, this resulted in slight growth of our fixed revenues.

We have seen solid inflow of our high-value KPN brand customer base, while outflow was mostly visible in our no frills brand, particularly at Telfort. The overall flat postpaid customer base means that the new mobile lineup we outlined for KPN in February has been successful and effective. Compared to the first quarter, postpaid ARPU was stable at EUR 17. Year-on-year, postpaid ARPU declined by 5.6%. As explained in the first quarter, this decline is partly related to customers that are renewing their subscription once every 3, 4 or 5 years instead of every 24 months, and they were on an old proposition with much higher ARPU levels. As a result of lower ARPU and flat customer base across all brands, we saw mobile service revenues declining by 5.8% year-on-year.

Now let's turn into the business, B2B. In Q2 2019, business revenues declined 5.5% year-on-year. This adverse year-on-year trend is still considerably impacted by our strategic actions to transform the segment.

In addition, last year's revenues were supported by nonrecurring hardware revenues, which is also the main reason that revenues from IT services are declining in the second quarter. Excluding this effect, we actually see solid growth in this part of the business. Moreover, the service revenue trend in the business segment was less negative than our total revenue trend as non-service revenues declined strongly in Q2 2019.

Furthermore, trends in business remained broadly similar as to what we have seen before: continued pressure on communication services, mainly driven by ongoing competition in the mobile market; a further decline in traditional fixed voice services, driven by migration to our target portfolio; and stable development in professional services and consultancy.

In business, we are accelerating the migration of customers to our target portfolio, the KPN ONE platform on our small business proposition. Currently, 59% of SME customers have migrated to traditional fixed voice and legacy broadband services, a significant step-up compared to the first quarter. And we have migrated 33% of LE customers. We aim to have all SME customers migrated by mid-2020 and all LE customers by the end of 2020.

In addition, we added 7,000 customers to our small business proposition, and 34% of these customers are currently on a converged portfolio. While we're facing a very sharp effect in line rationalization during these migrations, we see ample opportunity for up- and cross-sell of additional services. And this brings us to our value-over-volume strategy in B2B.

KPN has a very strong relationship with the majority of Dutch business customers, which we truly value. We understand our customer and our customers' needs. We aim for customer retention at market level pricing. We believe in a technology-agnostic future that is based on use cases that allow us -- our customers to do better business, like with the cloud communication. If we have price discussion on a single component, we actively look at the revenue mix or ability to broaden this.

The second part of our value-over-volume strategy is to increase our share of wallet by up- and cross-selling additional services. For instance, with connectivity, we start providing workspace management with Microsoft Office 365. With the move to Office 365, customers also moved to working in the cloud, for which we provide a comprehensive set. Once customers start working in the cloud, they often want this to be as secure as possible, and we can put a security layer on top. We have the clear ambition to become the #1 workspace provider in the Netherlands.

Finally, moving customers to the future-proof KPN platform improves NPS significantly, reduces churn and lowers the cost to serve. All this leads to a considerably improved customer lifetime value.

Now let me now hand over to Jan Kees to take you through the financials and the outlook.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [4]

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Yes. Thank you, Maximo, and good afternoon, everyone. Looking at the main financial metrics for the quarter, we reported revenues approximately EUR 40 million lower than last year; solid growth of 3.6% year-on-year in adjusted EBITDA after leases; and a free cash flow of EUR 147 million in total for the first half. I will explain each of these figures later in the presentation.

From this table, I would like to point you towards the row for adjusted indirect OpEx after leases. This is where you can track our current cost savings program.

But first, let's look more closely at our revenues. In Q2, our revenues declined 3.1% year-on-year. In Consumer, the decline was fully driven by lower mobile service revenues and mobile handset sales. Residential revenues grew slightly. The lower base for our traditional voice and DVB-T services was offset by growth in bundled services.

Business revenues were considerably impacted by our strategic actions. This strategy is designed to leverage our leading market position, high-quality brand perception and solid reputation to drive more profitable revenues in the years to come. As Maximo already explained, we continue to see ongoing competition in mobile, in particular.

Wholesale revenues grew 2.4% year-on-year, driven by higher mobile service revenues. Declining fixed revenues in wholesale from our legacy portfolio and international traffic were largely offset by higher revenues from our wholesale broadband access offering.

In the second quarter, adjusted EBITDA after-leases grew by 3.6% year-over-year. Effect of lower revenues was more than offset by lower cost of goods and services and net indirect OpEx savings resulting from accelerated simplification and digitalization. The cost of goods and services declined more than 7% year-on-year and was supported by lower hardware and license revenues in business and lower mobile handset sales. Personnel expenses was almost 9% lower compared to Q2 last year, despite an adverse effect from our new collective labor agreement that was concluded during the quarter. This strong performance was mainly driven by a reduction in own and temporary personnel. Expenses related to IT and technical infrastructure were almost 10%, lower year-on-year, and that was mainly driven by simplification of networks and IT, contract renegotiations and in-sourcing. Overall, we've seen solid growth of our EBITDA after leases and 280 basis points margin expansion.

The accelerated simplification and digitalization of our company is taking shape and already delivering significant cost savings. In the second quarter, we generated EUR 40 million of net indirect OpEx savings, bringing the total for the first half of 2019 to EUR 66 million. As explained earlier, the main categories behind these cost savings are personnel expenses and IT/TI. Savings related to personnel expenses are, for example, driven by improved organizational effectiveness as a result of removing management layers and, in addition, we have decreased temporary personnel in all our call centers, for example, as the number of calls continues to decrease, also by means of more digitalization. Savings in IT and TI are largely driven by simplification of networks, contract renegotiations with suppliers and in-sourcing to own personnel.

Our free cash flow generated for the first 6 months was EUR 260 million, down 37% year-on-year. This decline is mainly driven by a more negative impact from change in working capital and higher CapEx, which was mainly related to the accelerated fiber rollout. In addition, reported EBITDA in the first half was somewhat lower due to elevated restructuring charges. These effects were partly offset by less cash interest and less cash taxes base.

Let's move to the free cash flow development in a more intuitive graph. The strong year-on-year decline in free cash flow in the first half of 2019 was mainly caused by incidental negative impact from change in working capital. This effect is partly driven by higher CapEx in Q4 2018, leading to additional payments in the first 6 months of this year, and also by intra-year phasing of other spend, and by lower OpEx due to continuous cost savings.

As explained in 2017 also where we see -- we saw also an effect, significantly lower OpEx translates into a higher EBITDA that year, but not fully into cash conversion in the same year. Because of the payment terms to suppliers, there's a delay effect. I would like to emphasize that we expect this negative change in working capital to partly recover in the second half of the year.

In May, we redeemed a small, but high coupon bond. Together with the bond redeemed earlier this year, this will result in approximately EUR 40 million lower annual cash interest expenses as of 2020. In Q2, the average coupon on our senior bonds was 3.5%, some 30 basis points lower than last year.

At the end of Q2, net debt was EUR 90 million lower compared to the end of the first quarter, bringing the leverage ratio down to 2.4x. This was mainly driven by the sale of the remaining stake in Telefónica Deutschland and free cash flow generation during the quarter, partly offset by the payment of our final dividend over 2018 in April this year.

So we fully sold our remaining shares in Telefónica Deutschland on the 30th -- 13th of June. We received EUR 24 million dividend only this year compared with EUR 54 million last year. The proceeds, as well as the dividend received, will be retained to increase our operational and financial flexibility.

Let's move to our outlook for 2019 and ambitions for the 2019 and 2021 period. We updated our outlook for adjusted EBITDA after leases and now expect it to grow slightly compared with 2018. This is, of course, within our ambition to deliver organic sustainable growth in the 2019 to 2021 period.

CapEx outlook for 2019 is expected at EUR 1.1 billion.

For 2019, free cash flow outlook, we expect front-end loaded restructuring charges and adverse phasing of working capital to lead to incidentally lower free cash flow compared to 2018. For the full 3-year period, we reiterate free cash flow CAGR in the mid-single digits, including this year, driven by growth in EBITDA after leases. The year-to-date development of our cost savings program provides confidence to the midterm free cash flow performance.

It is very important to look at our free cash flow performance in 2019 as part of our 3-year sustainable growth ambition. In the second quarter of 2019, we saw a solid EBITDA growth and structural free cash flow drivers are intact. The impact of materially higher restructuring cash out in 2019 is partly mitigated by natural employee attrition. But this is, in turn, offset by change in working capital. So the positive impact from natural employee attrition is balanced off by negative delta in working capital. We expect the change in working capital to partly recover in the second half, however, to remain elevated on a full year basis. As indicated before, also in 2017, we have seen that the working capital effect was driven by ongoing spent reductions from our cost savings program. Similar to the benefits of restructuring, these cost savings will be visible as free cash flow improvement with some delay. Despite incidentally lower free cash flow in 2019, we intend to grow the regular dividend over 2019 to EUR 12.5 per share. The progressive dividend reflects our confidence in the execution of our strategy for the coming years, which will deliver organic sustainable growth.

Thank you. And now I will hand back to Maximo for a few concluding remarks.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [5]

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Yes. Thanks, Jan Kees. Let me briefly wrap up with the main takeaways.

Our performance in the second quarter reflects the progress we made with the execution of our strategy. In Consumer, we see the impact of our brand strategy, resulting in less acquisition at the lower end of the market, but also in stronger household relationships.

In Business, strategic actions continue to impact our top line but increasing customer satisfaction provides additional confidence we are on the right track.

We achieved significant cost savings in the first 6 months of our new program, driven by the accelerated simplification and digitalization of our company.

We recorded solid growth in adjusted EBITDA after leases, and free cash flow in the first half was mainly impacted by negative change in working capital and higher CapEx. We expect adjusted EBITDA after leases to slightly grow in 2019. We expect incidentally lower free cash flow compared with 2018, due to front-end loaded restructuring charges and adverse phasing in working capital. We remain confident to reach our medium-term ambitions.

On a final note, as announced in June, pressing family reasons has led me to resign as CEO of KPN and return to Italy. I am confident that I will leave KPN in very capable hands, backed by the strong executive team that we have created in the company, and that now we have in place.

I would also like to thank the Boards, my team and everyone involved in KPN for their support during my tenure with KPN. Thanks very much.

Now we can turn to your questions.

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Bisera Grubesic, Koninklijke KPN N.V. - Head of IR [6]

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Yes, ladies and gentlemen, we are ready to start with the Q&A. (Operator Instructions) Operator, we can start with the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is coming from Keval Khiroya, Deutsche Bank.

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Keval Khiroya, Deutsche Bank AG, Research Division - Research Analyst [2]

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Two questions, please: One on your EBITDA guidance and one on mobile. So on the EBITDA guidance, obviously, you have a more optimistic view on fully EBITDA versus what you announced at the full year results. Can you talk a little bit more about what's driving this more positive view? Is it driven by OpEx reduction? If so, where are you seeing better OpEx cuts than what you expected previously?

And then secondly, you mentioned that mobile is still clearly very competitive. However, we have seen Simple being less aggressive on their pricing and T-Mobile recently announced some small price increases as well. Do you, therefore, think that there are signs of the mobile market improving at all? And how should we think about your mobile revenue trends for the second half? Will they be similar to what we saw in the first half? Or do you think there is room for improvement?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [3]

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Yes, let me take the first question and Maximo, the second. So on your first question, yes, it is driven by OpEx reductions. Actually, the OpEx reductions are across the board. It's FTE, own personnel, it's also external spend on IT, mainly, those are very big buckets, IT external spend and FTE spend on basically our own personnel because of reducing management layers, making the company more simple. Digitalization of services means that we can provide services with less people. Also on the call center, less temporary personnel because of the digitalization. Through an app, for example, we are able to provision services, but also to answer questions for people without them calling to our call center. So we see a continued reduction of calls to our call centers, which enables us to also lower the number of people at the call centers. So it's actually across the board. And we are, I would say, more than on track on our OpEx reduction, which is feasible in Q2 that has led us to the confidence of upgrading our EBITDA guidance for the full year.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [4]

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Yes, on your second question, mobile development. Yes, the market, as you said, remains, of course, a highly competitive market. It is true that recently there have been some very light price increases, which is always a good sign. We don't give any guidance in terms of how the market is becoming more rational. But of course, we can say that we see some behaviors that are going into this direction, but for the moment, remains a highly competitive market.

When it comes to KPN, in this quarter, in the second quarter, we have been able to keep our customer base stable. So we had net adds that are not negative. In particular, on the KPN brand, we have been able to get plus 17,000 positive net adds, which is always a good thing. And at the same time, the ARPU has not deteriorated quarter-on-quarter, and we expect ARPU to remain stable for the next -- for the rest of the year.

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Operator [5]

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The next question comes from Mr. Polo Tang, UBS.

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Polo Tang, UBS Investment Bank, Research Division - MD & Head of Telecom Research [6]

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I just have a few questions. Really, just a clarification in terms of cost savings. Because obviously, you're making very good progress. Great you fully updated for EBITDA, but how should we think about the $350 million of net savings that you've outlined? So can that number move higher? Or are you just pulling forward the cost savings at a faster rate? So can you maybe just give some commentary potentially about the profile of those cost savings over the next couple of years?

My second question is really just on B2B. How should we think about top line trends for B2B, both over the next couple of quarters, but also looking into 2020? So specifically, we have easier comparables for Q3 and Q4. You mentioned about the difficult comparable in Q2 because of hardware revenue. So is there anything in terms of one-off factors to consider that that might mean that you won't see some modest improvement in terms of top line trends in B2B in the coming quarters? But also, if we think about B2B revenues going into 2020, you're obviously making very good progress in terms of migrating subscribers over to new products. So could we maybe approach stabilization of B2B revenues as we look out into next year?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [7]

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Yes, Jan Kees, will take the first and I'll take the second?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [8]

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Yes. Well, of course, I cannot deny the reduction of OpEx spent. In total in the second quarter was very much on track. And probably also outperformed some expectations. However, we did not upgrade yet the EUR 350 million. That's still a figure that we reiterate for the full 3-year net savings of EUR 350 million. Of course, as Mr. Tang also remembers probably very well in the past few programs, after -- sometimes after year, in the past, we have upgraded it, but we are now only started this new program, 6 months in the new program. So it's too early to say anything about the total EUR 350 million.

But what I can say is, certainly, it provides us a tailwind and confidence that we will deliver that. It's going very well. It's structural cost savings. You also see it in the margin improvements. You see it translating in the P&L in the indirect cost, OpEx line. So it's also very visible and transparent. And of course, there's always a bit of phasing from quarter-to-quarter. A EUR 40 million reduction in 1 quarter, 66% for the full half year with the program that we have just started, is at least a positive one to start a new program, I would say.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [9]

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And on your second question about the B2B. Our ambition in the B2B is to stabilize EBITDA in -- by mid-2020. So this is EBITDA end-to-end, and we have that goal for next year. But when it comes to revenues, there are some considerations that have to be made.

In this moment, we are, by design, strategically, we are working in order to migrate as, I mean, most if not all, our SME customer base and large enterprise in 2020 into our new platforms, KPN ONE and also to increase the penetration of the new value propositions that we are launching in the market.

That, of course, means that when you migrate customers from the legacy platforms into the new platforms, you have some rationalization of your communication services, in particular. And that's why when we look at the communication and connectivity revenues, we still have a negative performance in terms of revenues year-on-year.

But there are also other items, like, for example, IT, where, if we exclude this, the hardware and the licenses, we have a positive growth of more than 9% year-on-year. And that's also the result of working less on hardware devices, licenses and just focusing more on the service revenues.

By the way, in the second quarter, we have a better performance in terms of service revenues than the total revenues. Of course, we expect that at the moment the migration will be completed, that the new smart combinations will be in the market and they will also complete our program of rolling out Fibre-to-the-Cabinet and Fiber-to-the-Home in most of the business parks, then we will start seeing a better trend when it comes to revenues.

But first, the ambition is to look into end-to-end EBITDA that we will stabilize by mid-2020. And then, in the next quarters, we will see a better performance and a better trend in terms of revenues.

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Operator [10]

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The next question comes from Mr. Sam McHugh, Exane.

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Samuel McHugh, Exane BNP Paribas, Research Division - Analyst of Telecom Operators [11]

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I just wanted to follow up on the working capital, I'm sorry, to be a pain on that. I mean you're saying you expect some of it to reverse. Can you kind of give us a rough kind of guide as how much will reverse in 2H? And then again, for 2020, should we be thinking about a similar pattern of working capital?

And then just secondly, on your new Fiber-to-the-Home build, you're obviously only at 40,000 homes today. Just wondering if you can talk about kind of early success, kind of take-up rates, anything you're seeing would be super interesting.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [12]

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Well, I can take the first one or second and...

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [13]

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Do you want to do the first one?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [14]

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Yes. It's becoming the rule of thumb?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [15]

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Yes.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [16]

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So yes, let me -- let me -- I also read some of the comments of sell-side reports. So I cannot imagine that you need a bit more explanation on the working capital movement because it's quite a complex matter. So there's a lot of things happening.

First of all, of course, we have always the regular phasing in the first half of the year of free cash flow because invoices for rent, interest payments, some other related costs to external spend sometimes are paid in the first quarter or the second quarter more than any other quarters. That's a normal phasing that you see every year, and that's also this year.

Then on top of that, there is extra incidental effects that have an effect also for the full year 2019 but had more effect for the first half of 2019. So that's why we say, partially, this effect will reverse.

What are those effects? First of all, and this will be -- we will carry mainly also through the whole year, there was a, as you also have seen in Q4 of 2018, a CapEx spike, an elevated level of CapEx in Q4 2018, which has been paid in the first half of this year. If we would have had that same CapEx phasing this year, then there would be no difference because the total CapEx remains this year the same as last year, EUR 1.1 billion. But you see that the CapEx phasing this year is different. In Q1, Q2, we have spent much more on CapEx. So as a consequence of that, we will spend less on CapEx in the second half of this year. And a big part of the CapEx that you spent at the end of the year, will be paid in the next year. So this effect will be less this year. It was there last year, hence, that's why we have cash out, partly of CapEx last year, but still have a lot of cash out for the CapEx this year, relatively more cash out than on the CapEx last year. This is an important effect, and that effect will also be there for the full year.

Then we have the OpEx. Why does lower OpEx -- structurally low OpEx also translates into an incidental negative effect on working capital? OpEx on FTEs, on own FTEs does not translate because we pay salaries also immediately. But OpEx to external suppliers are paid with 60, sometimes 90 days of payment terms. So a structurally lower OpEx level also leads to a lower level of accounts payable, or, in other terms, if you see through the year an effect of stepping down in OpEx, that effect of lower OpEx immediately translates into an improvement of EBITDA but does not immediately translate into EBITDA to cash flow conversion because of the delay of the payment terms on the OpEx that is paid to suppliers. 60, 90 days, for example, there's a lot of different payment terms. So this effect will also be there this year, as we have seen in 2017, where we also had a significant OpEx step down, especially also in the second half of that year. And now we already see a lower level of OpEx this year, continuing also throughout the year, so leading to lower accounts payable and worsening of the working capital. That will also, of course, flee back next year.

Then there's -- an extra effect also is that the CapEx that we spent this year is a bit more skewed to fiber rollout. And there's a difference in payment terms on fiber rollout compared to other CapEx items that we had more in last year. Fiber rollout, typically, also requires digging by building companies. And they typically want to have a prepayment, a significant prepayment, before they start the work, whilst a lot of other CapEx buckets are actually paid after finishing or with some payment terms during the construction phase. But in a fiber rollout, a big part of the spend is digging. And that has to be prepaid in advance, at least in the part. And we will see that in the second half of this year, we have to pay some extra prepayments on our fiber rollout.

All in all, that effect actually balances with the more benign cash out on restructuring for this year than originally anticipated because of the natural attrition. The Dutch labor market is actually on a very high, very positive level. That means that more people than originally expected leave on their own, which saves some restructuring charges, but that effect is offset by the working capital effect. So this effect, we also show it in 2017, doesn't naturally translate into other years at the same level. This year, normally, you would see a somewhat higher effect of this effect than we have in normal years.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [17]

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Yes, when it comes to fiber, of course, it's too early to see the benefits that we expect. Because in this moment, we are building, rolling out and we are intensifying all our efforts. As I mentioned earlier, we have approximately 19, 20 areas, where now we are simultaneously rolling out fiber. At the same time, we have already passed into Fiber to the Home 40,000 households as part of our program or the 3-years program. We already started also testing the XGS-PON technology for the fiber rollout in order to be more effective and more efficient. And another important aspect is that, just as a point to reference, if we are currently doing 100, in the end of the year, we will do 100x 4, which is that we are just at x4 in terms of customers that will be activating Fiber-to-the-Home connections. And that is really important because it means that now we are accelerating. We expect, by the end of 2019 and beginning of 2020, to see materially the first results of all these efforts.

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Operator [18]

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The next question comes from Mr. Frederic Boulan, Bank of America.

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Frederic Emile Alfred Boulan, BofA Merrill Lynch, Research Division - Senior Analyst [19]

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Firstly, just a follow-up on the previous question around your cash flow. So if you look at the real level of restructuring so far more or less doubled year-on-year. Looking at the other moving parts, how do you feel about expectations from the sell-side right now on free cash flow, which I think, at around EUR 730 million? I mean is it reflected in your guidance of material reduction with the effect from attrition and working cap?

And secondly, if we could come back on your comments earlier around mobile ARPU. So just trying to understand, looking at your mobile service revenue trends in Q1 and Q2. Going forward, is it fair to assume that we expect a material improvement, if you can maintain a stable customer base and a stable sequential ARPU? Or we should not be too hopeful for those trends to normalize anytime soon?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [20]

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Again, the number one on cash flow?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [21]

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Yes. So we didn't mention still a specific number on free cash flow that we will hit this year. That is also because we still want to have the flexibility as explained in January, on reducing even a bit more people if that brings structural savings for the company. So it's something -- there's a very good return. And -- but it means a little bit more cash out. That's why we do not have a specific cash flow target this -- for this year, yet.

However, what I can say is that the effect of the working capital, as mentioned, with the regions, as mentioned, first, it will partly reverse in the second half of the year. And for that part, that it will not reverse, it's fully offset as we expect now by lower restructuring charges than originally anticipated. So there is a balance in between those 2, giving us -- providing us still the flexibility, but also providing us the full confidence to reiterate the free cash flow growth for the 3-year in a mid-single-digit CAGR. And if you calculate that, lower level this year, but in 3 years, including this year, mid-single digits CAGR on free cash flow, well, you can make your own assumptions on that. That means that we have to perform very well in second and third year of this period on free cash flow. And we have reiterated that, so you can make also your conclusions of that, that it provides still the confidence on free cash flow, but also remains a little bit of the flexibility we need to make the right decisions for the company in order to do the right thing to reduce as much as cost as we can.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [22]

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Yes, mobile ARPU, I think that the key elements are that in this second quarter, we were able to post positive net adds or at least not negative in the last mobile, which I think is the first time over the last 5, 6 quarters that is positive.

It's difficult to predict the level of net additions going forward. But what I also can say is that there are some signals in the market that go in the direction of a more rational competition. Again, it's still too early because, as I said, competition remains very intense. But that is what -- at least, what we see.

Another aspect is about the ARPU. The quarter-on-quarter ARPU is stable. We expect it to remain stable for the rest of the year. Of course, we are working in order to improve that. We are trying to improve that in terms of up-selling customers into better bundles to make sure that when new customers come into our base, they can subscribe better bundles. This is the normal effort that we do in marketing in order to improve that. But for the moment, what I can say is that we don't expect any deterioration on the level of the ARPU for the next quarters compared to the second quarter.

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Frederic Emile Alfred Boulan, BofA Merrill Lynch, Research Division - Senior Analyst [23]

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And I don't know if I can ask an unrelated follow-up regarding CEO transition about a month after the announcement. So when could we expect an update from the company on that process?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [24]

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Yes. I mean this is, in this moment, in the hands of the Supervisory Board. Our Supervisory Board is managing that. And I cannot -- we cannot comment on that.

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Operator [25]

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The next question comes from Mr. Usman Ghazi, Berenberg.

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Usman Ghazi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [26]

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I just got 2 questions, please. Firstly, on Business mobile. I can see in the mobile net adds, you were down 58,000 this quarter from being broadly flat in the previous quarters. I mean is there a bit of contract loss or something of the like that has happened this quarter in Business? That was the first one.

The second question was just on the working capital commentary that's been given. Is it -- I guess, if I can frame the question slightly differently. I mean is the working capital drag from these other effects that you've mentioned, is that coming in higher than what you anticipated when the guidance was set at the beginning of the year? And if so, does that just reflect the fact that you've got better momentum on cost savings than you had anticipated?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [27]

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Yes, this time, I'll start with the first, and you go in the second. On the B2B, every time there is discontinuity in terms of the net adds, mobile, in particular, it's always because of you gain some contracts or you lose some contracts. And of course, sometimes, it's just because of phasing of that. So when you get a customer, sometimes you start activating SIM cards in the next quarters or in the next month; or when you lose a contract, you don't lose all the SIM cards or all the activations that you have at the same time. So that is reflecting the phasing. And of course, is depending on some contracts that have been lost, but at the same time, some of the contracts have been gained. I don't remember all the names by heart, but this is the situation that has happened.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [28]

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And on the working capital. Yes, I -- probably it's fair to say that when we set the ambitions and also this year, ambition on the free cash flow, for this year, the working capital effects, the delta on working capital is a bit -- for this year, a bit worse than expected at that time. But that amount is roughly, as I also explained, the same, and that's why it's evened out, as the effect of less restructuring charges that we also expect now. So all in all, the net effect is not significantly different as when we set the ambition. That's why -- but also, we have reiterated, in the press release, our 3-year CAGR, mid-single-digit growth on free cash flow, annually, including this year, where it will be lower then because of the elevated elements that is mentioned also.

So all in all, the effect will be the same, and we reiterated our 3-year ambition on free cash flow, which we can do with confidence because of the 2 effects.

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Operator [29]

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The next question comes from Mr. Luigi Minerva, HSBC.

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Luigi Minerva, HSBC, Research Division - Senior Analyst [30]

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Yes. Just on the personnel cost, where there was a very strong progress. Should we now take this quarterly expense as the new normalized number? So can we extrapolate, going forward, that roughly EUR 250 million a quarter in personnel is the right level?

And then secondly, on the Business segment. I have a question on the broadband net adds, which are up and stronger, but also the ARPU for broadband is down. And I found it a bit counterintuitive, given your value-over-volume strategy. So if you can give us more color on that?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [31]

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Take the first?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [32]

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Yes. We expect labor-related spend, including FTE costs, to continue, actually, to reduce, not necessarily, of course, with the same rate. But the reductions that we have locked in, in Q2, which we were much higher than in Q1 reductions, they are structural. Most of it is structural. And on top of that, we will have further reductions as well, which will result in lower, even lower spend, but not necessarily in the step-down, will be at the same pace. But certainly, labor-related spend will be, looking forward, lower than it is now even further. And as to the reductions, we reiterate what we have said earlier and also the spend reduction.

So the total spend program is EUR 350 million net indirect OpEx spent less. A big part of that, of course, is FTE related. So again, that means that we still have to do a lot of work, and we see still a lot of potential for the next few years to reduce further costs down.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [33]

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On the B2B. The fact that we are increasing the broadband base, and in some quarters, we could have a slight reduction of the ARPU, is not contradicting our value-over-volume because in the end, when it comes to communication services, like mobile connectivity, broadband, there is always a high marginality, so the EBITDA margin is quite high.

So in some contracts, we can get some additional broader lines, with maybe a discount, but that is always in line with the value over volume because these contracts are value for the company.

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Operator [34]

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The next question comes from Mr. Roman Arbuzov, JPMorgan.

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Roman Arbuzov, JP Morgan Chase & Co, Research Division - Analyst [35]

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The first one is on Telfort brand shutdown and the impact on your net adds. So in terms of the impact that we saw in the quarter, I just wanted to check whether the impact was, firstly, in line with your expectations, specifically in terms of net adds?

And secondly, would you expect similar trends for the remainder of the year? There was some pressure in your fixed line -- across the board pressure in your fixed line net adds.

And also more broadly, thinking about the Telfort shutdown exercise from a bigger picture perspective, do you still feel confident that it's a positive exercise?

And I was also wondering, to what extent are you relying on the general market price increases to make this a net-net positive for yourself? Because, I guess, part of your -- part of this -- one side effect of this exercise is that you're essentially raising prices. So do you think that it's something that is required for your competitors to follow for this to make it work for you? Or is there a scenario where you basically just end up missing out in the lower end of the market, and this will hurt you longer term. So that's one bucket of questions.

And if I can squeeze a second one in, on the gross margin, please. So one of the interesting developments this quarter has been quite a substantial increase in your gross margin. And despite the fact that your top line continues to decline at a meaningful rate of 3%, the impact on your gross profit is getting less and less significant. So I was wondering if you perhaps, Jan Kees, can give us a little bit more color on when we may expect to get to a point where top line declines actually will not lead to an absolute decline in your gross profit because of the increasingly favorable product mix.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [36]

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I'll start with the first question. I believe -- we believe that the one brand integration or integration of our brands in one is really paying off. Of course, when you run this program, there could be some moments where you see maybe a decline in the customer base. But there is always a beginning.

Let me articulate this better. We started with Telfort. So we closed the shops, the 1st of May, the online China as well. Then what we did is that we closed -- I mean, definitely, Telfort for sales, which means that you keep the customer base, but then there are no more activations on the Telfort brand.

The first result of that is that if some customers are looking for the low end bundles of Telfort, then those customers will not find these low end bundles anymore. So our intention was to move those customers into the low end bundles or medium bundles of the KPN brand.

To give you an example, on Telfort, on average, we had a bundle of approximately EUR 35, when it comes to broadband subscription. The moment this is transferred into KPN, it is EUR 42.5. So we have the first positive impact, which is that we increase the inflow, the inflow ARPU.

Of course, at the same time, you have less activations on broadband on the Telfort because you can recover some. But now we see that in the trend that we see and we monitor every single week, this number is increasing. This is on broadband, or Mobile, the -- all the missed or missing Telfort activations have been fully recovered by the KPN brand, which is another positive information because it means that customers are now moving into the KPN brand, there is premium compared to Telfort.

So in general, this has been a very good move. Of course, you have less activations. You can have at a certain point, a little bit more deactivations, in particular at the beginning, but now all these trends are stabilizing. So the strategy is following exactly the path that we'd assigned for it. And I truly believe that this is paying off.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [37]

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Yes. And as to your margin question, I'm not sure what you were pointing out, but because -- yes, the margin is 280 basis points, growing considerably, revenue is still in decline, that is more than offset by cost reductions. Part of that is because the revenue that is in decline is...

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Roman Arbuzov, JP Morgan Chase & Co, Research Division - Analyst [38]

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Sorry, Jan Kees. I don't know if my line is open, but I just wanted to withdraw -- I was talking about -- I know you typically communicate in terms of EBITDA margin, but I was particularly focused on the gross margin. I gather it's just because we've spent quite a bit of time on OpEx. I was particularly intrigued by the fact that your cost of goods sold have come down quite a bit this quarter. So if you look at the gross margin, so before the indirect OpEx, they've improved quite a bit. And my point was that, despite the fact that your top line continues to decline at 3%, the absolute drag on your gross profit, as a result of it, is getting smaller and smaller. Just -- well, presumably because it's the mix that is improving, you're dropping lower margin revenues, and you're focusing on more profitable products.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [39]

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Yes.

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Roman Arbuzov, JP Morgan Chase & Co, Research Division - Analyst [40]

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So I was just wondering if you had in mind a particular point, for example, when, despite the top line being down, it will actually stop being very relevant for KPN because you guys will get to a point through the migration to KPN EEN and generally, kind of the upgrade of your customers to the next-generation products, you'll eventually get to a point where you will start growing gross profit, even with falling top line. And I was wondering if that point may be around the corner and whether you had any particular views on that.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [41]

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Okay. All right. Okay, I understand. So well, we do not have a specific guidance on the moment of inflection on gross profits, on absolute gross profit. What I can tell you is that, yes, what you see happening now is a result of 2 elements. So first of all, revenue is still in decline. And part of that revenue, that is in decline is a deliberate choice of low-margin revenue, that is in decline, which also translates, as you have seen, in cost of goods sold, down also. So that could translate into an inflection moment earlier than revenue inflection because you see that part of that revenue that is going down is actually a deliberate choice of lower and hardware or licenses resells, et cetera, et cetera, especially in Business markets or handset sales. And part of it is margin improvement because of the indirect OpEx improvement.

But that's what -- now you're talking about the -- more the direct OpEx line, which relates to the revenue. And yes, that's also going down very significantly because that's part of the strategy that some of the revenues that we see at a very low margin that is being dealt with.

So we do not guide a specific guidance on inflection of the gross profit. But yes, that will certainly continue to improve next quarter, but also is -- there's always some seasonality as well, of course, in that.

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Operator [42]

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Ladies and gentlemen, we've run out of time. We have time for one more question coming from Mr. Paul Sidney, Credit Suisse.

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Paul Sidney, Crédit Suisse AG, Research Division - Research Analyst [43]

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I just had a couple of questions, please. Firstly, on strategy. I was just saying, is KPN willing to continue to lose low end Consumer mobile postpaid customers, and indeed, maybe some low-end broadband customers to help drive profitability higher? Or does there come a point at some point in the future, where you look to reverse the value of a volume strategy? I guess putting it another way, does it become a sort of tipping point, where you say we can't really afford to lose any more subscribers?

And then secondly, on shutting down of the legacy networks. Is it possible to give us a bit more detail on the process of shutting down parts of the legacy network, the types of cost savings you're seeing as a result and if there are any regulatory implications associated with shutting down that part of the network?

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [44]

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Take the one, you first? Second?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [45]

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Yes, the second sorry.

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Maximo Ibarra, Koninklijke KPN N.V. - Chairman of the Management Board & CEO [46]

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, Yes, on the strategy, I mean, it's for both the segments, of course, B2C and B2B. We are not looking at the -- I mean, keeping the customer base stable as like the main principle. For us, it's important that we can keep the customer base stable, in particular, when it comes to the high-end segments. In Consumer, it's converged. So all the strategy we have is converged. And that's why we insist a lot of that, and that's why we are rolling out fiber, and that's why we are also working on new value propositions because we need to become the real super leaders in the market when it comes to converged household propositions.

So we look at the mobile only. We look at the broadband only. But this is not the main goal of our strategy. The strategy is just really moving into fixed mobile with other services in the future, so we can really get the customer lifetime value we want, which is also the result of the right churn rate, the right ARPU. And we see that in the areas where we roll out fiber, and we get activations from fiber, I mean, this performance is coming.

So again, it's converged. It's not mobile broadband stand-alone. The moment we go more into the broadband -- sorry, into the converged, then we notice that we can also increase the mobile customer base because the moment we have a converged proposition, then we can add up more sinkers, the sinkers of the family. So then at the end, the number will come.

That on the Consumer, on the B2B, is exactly the same. So KPN ONE in the end is a converged platform. That will, of course, provide us a lot of value-added in terms of customer experience and also the KPIs that we have repeatedly stated in terms of the good things that could happen the moment a customer is moving from the legacy platform into the KPN ONE. So the concept is the same. We can up-sell more services in a converged way.

And when it comes to the large enterprise and corporate, it's just getting rid of all these revenues that are not providing us any marginality. That's what we don't want. And that's why also, we are working more and more on service revenues and less on hardware devices and licenses. So the strategy is really value-over-volume is not looking at the number of customers as the main principle. It's more the number of customers on converged propositions from both segments.

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [47]

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Yes, on the legacy networks, yes, it depends on which legacy services. But yes, many legacy services shutting down have regulatory consequences. You have typically there a grace period between the announcement of shutting down that legacy service and the actual decommissioning of the legacy service. That's also why we have in the past did that formal announcement to the market that also binds our wholesale partners on those legacy networks. So it gives them also the time to let them customers migrate; gives us out the time to migrate our customers. That's also why we are doing it now, and in that process, and especially on regulatory services like PSDN and ISDN, in which cases, we also can sometimes provide alternatives that are seamless. For example, PSDN, we can emulate typically from the seat cabinet. So with a 0 touch for the customer. But yes, there's a grace period. And that's why also we take time for that and do it also in a face-by-face approach and also region-by-region approach.

Typically, when you have a big region where you can decommission all those legacy services, then you can already take in that region, a full benefit of the related OpEx reductions and also maintenance CapEx reductions. And that's very substantial. So it's also in our interest to do it wisely, of course, because it's also about managing your revenue streams and creation path. But on the other hand, also do not lose track of the potential cost reduction. So the cost reductions that you are seeing now, actually, are not yet a result mainly of those switching down of legacy services because those are future extra cost reductions, mainly, that we can take it.

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Paul Sidney, Crédit Suisse AG, Research Division - Research Analyst [48]

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And just a follow-up, is there any sense of the cost savings aligned, just in rough terms?

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Jan Cornelis De Jager, Koninklijke KPN N.V. - CFO & Member of the Management Board [49]

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We did not -- it's a good question, of course. And we -- at the Capital Markets Day, we gave a lot of demonstrations to give more understanding on how this works and why the cost savings are there. And they are quite significant because there's a lot of cost. Labor, especially also related to the maintenance and keeping up legacy networks. So switching it off will be very substantial, not only in terms of maintaining those networks, but also in terms of provisioning services on those networks.

At the Capital Markets Day, we gave live demos, for example, there's a typical VPN type of service, for example, now requires up to 20 different actions, even 3 sending in a physical engineer to a location that we can substitute by only one labor action, one menu action, and provision that service in half a day rather than in 6 weeks. So the potential of legacy networks, especially combined with the software-defined networking opportunities, as a result of that, also emerge, are huge and only are only in a small part, are already captured in many models, I think, from analysts.

So that's -- but it will take years and years, of course, but that's also why we are very confident that an incumbent telco, like KPN, can, for many years, even more than expected probably, be able to reduce its cost -- its spend going forward, and at the same time, improve the quality of the services to the customer, shorter provisioning times, better Net Promoter Scores to the customer, more agile provisioning of services at a much lower cost to serve those services.

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Bisera Grubesic, Koninklijke KPN N.V. - Head of IR [50]

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This ends today's presentation. Thank you, everybody, for joining us, today. And if there are any further questions, please reach out to our Investor Relations team. Operator, you can close the call.

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Operator [51]

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Ladies and gentlemen, this concludes today's presentation. Thank you for participating. You may now disconnect your line. Have a nice day.