1 Telefônica Brasil S.A. MANAGEMENT REPORT Dear
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Telefônica Brasil S.A. MANAGEMENT REPORT Dear Shareholders, In compliance with legal and statutory provisions, the management of Telefônica Brasil S.A. (Telefônica Brasil) hereby submits for your appreciation the Company’s management report and separate and consolidated financial statements, together with reports issued by the independent auditors, the board of directors, the fiscal council and the audit and control committees for the year ended December 31, 2016. 1. Message from Management Having headed Telefônica Brasil since November 16 after spending 12 years at Telefônica’s headquarters in Spain, I can assure you that I have taken over a company that is ready to be a major player in the digital transformation of society. Therefore, I felt confident on committing to continue the project started by my predecessor to consolidate Vivo as the telecommunications sector’s leading operator, focused on offering the best connections between people, companies - and increasingly objects, too - thus continuing to boost Brazil’s digital transformation. I would like to emphasize my commitment to continue helping our customers enjoy all the digital world’s opportunities as part of their lives through the best connectivity, best services and best customer experiences, adding value for our shareholders and delivering consistently solid financial results. In relation to 2016, despite a challenging economic scenario, I am pleased to note that the Company attained high levels of operational excellence and commercial performance. Our financial results and major accomplishments made us a standout in the sector: Outperformance in the market1 Telefónica Brasil showed strategic vision in tackling issues related to the unstable macroeconomic context and the downward trend in the use of voice lines. The Company was the only operator to grow revenues and profitability in a year of contraction for the telecommunications sector. Revenues grew to R$42.5 billion. while recurring EBITDA consistently rose (7.3%) to R$13.7 billion. For 2016, our shareholders obtained a substantial 30% rate of return2 (calculating share price gains plus dividend payouts in this period). The Company strengthened its position as mobile leader as its market share rose to 30.2% with 73.8 million accesses in December. We also continued to lead the high-value post-paid segment with a 42.1% market share and 38% of net additions. Our commercial strategy boosted mobile ARPU 13.1% against the previous year. Our wireline network kept pace with fiber optic expansion to ensure excellent customer navigation experience with ultra-broadband speeds of up to 300Mbps. 1Combined proforma cenario including GVT Participações as of January 1, 2015 2 Referring to VIVT4 preferred shares 1 High-value synergies and increased efficiency Our acquisition of GVT in 2015 afforded the company a great opportunity to capture value through synergies and our execution in this respect accelerated in 2016. We concluded our integration plan for the two companies to show more value-creation potential than we had initially estimated from our due diligence reports. By December 2016, disciplined execution of the integration plan secured 71% of estimated best-scenario net present value of synergies. The integration process raised revenues, lowered costs and optimized investments while adding R$1.4 billion to cash flow (direct and indirect) in 2016. In addition, it strengthened triple play offerings and paved the way to roll out quadruple play offers in the future. Since the beginning of the process, we have been working hard to seize every opportunity to strengthen our position in the mobile business, ultra-high speed broadband, pay TV and the corporate market, by leveraging and integrating Vivo and GVT assets and drawing on their best business models. At the same time, we introduced cost-control programs and held our expenses well below inflation. The IPCA ended the year up by 6.3% whereas our recurring expenses were down by 1.9%3. To cut back expenses and reach higher levels of efficiency, we introduced rationalization initiatives for all of our BUs. Among other accomplishments, the company heightened energy efficiency, lowered inventories, renegotiated rents and optimized building maintenance and security expenses. Digital transformation speed up Telefónica Brasil is a key player in the digital transformation that is now reaching every sector of the economy and doing so faster than ever. In addition to investing in our networks to offer the best connectivity to our customers, we are working to develop 100% digital products and services for 100% digital customer journey. We are making life easier for our customers through Meu Vivo, a user friendly app that gives users anytime-anyplace access to their mobile account details in order to check their internet usage or acquire data packages quickly, flexibly and conveniently, among other benefits. The app is increasingly becoming the main totally digital relationship channel and its total downloads were 144% higher in 2016. Another important step for digital interaction with customers was the creation of Vivi, a virtual assistant available to customers on Vivo’s website and, since November, also accessible using Facebook’s Messenger tool. We were the first operator in Brazil to create a digital channel of this kind. However, we are also backing the use of Big Data as an important lever to optimize decision making. By using this tool, we multiplied our processing capacity by a factor of 87 in 2016. Vivo has created a high performance center for this area (Vivo Data Labs). From the myriad apps in use, Big Data enables us to analyze customer behavior and find the best offerings for each profile, heighten the precision of the network’s investments based on customer locations, and identify and prevent the main causes of customer dissatisfaction. At the same time, we adopted a more transversal management model by organizing project - centered squads combining people from different backgrounds in marketing, HR and IT in order to solve problems and roll out products faster. Digital transformation requires agility and Vivo is ensuring that it makes the grade. Finally, an additional lever of great importance for our digital transformation is Telefónica’s Open Future program for driving innovation and supporting new entrepreneurs. This initiative makes us 3Combined proforma scenario including GVT Participações as of January 1, 2015 2 part of Brazil’s innovation ecosystem and also energizes Telefônica’s operation by posing an opportunity to boost operational efficiency, help envisage new revenue sources and identify innovative and complementary products and services. We have already signed partnerships with nine startups accelerated by Wayra, a gym affiliated with the program, and we are looking at proof of concept outcomes with another six. Continuously improving customer experience Most of the R$8.0 billion4 we invested in 2016 went into network infrastructure. We have strengthened our quality differential in the mobile market by expanding our 3G and 4G networks, particularly the latter. Our 3G coverage reached 3,652 municipalities - the sector’s largest - and 4G technology had reached 516 cities by December. In the landline segment, the FTTC network expanded to six cities in São Paulo state and two cities out of state. We ended the year with a total of 5.7 million homes passed (HPs) using FTTH (Fiber-to-the-Home) technology. Average browsing speed for our fiber-line customers reached 43 Mbps. In addition to investing in connectivity, we scrutinized every point of contact between customers and the Company. In 2016, we stepped up deployment of our Quality Plan, which had been launched in mid-2015, involving initiatives such as product portfolio simplification, automation, expanded digital services and simplified internal processes as well as progress on fixed telephony system integration. We have now concluded 105 Quality Plan initiatives and we will be following through with more in the course of 2017. Concluded initiatives have directly improved services for our customers and this has already been reflected by a double-digit reduction in the contact rate at our Relationship Center last year. A highlight in our product portfolio was the Vivo Família plan, an innovative initiative with a mobile Internet franchise that may be shared by the whole family. Sustainable socially responsible growth For the fifth consecutive year, we were one of the select few companies comprising the BM&FBovespa’s Corporate Sustainability Index for 2017, thus reflecting our pursuit of efficiency throughout the value chain and continuous improvement in the company’s governance. The company continued to take measures to reduce electricity consumption and use an energy matrix that prioritizes renewable sources. Today, about 22% of energy consumed comes from this kind of source. In addition, since October, Vivo has been using the Eco Rating mobile phone seal based on criteria covering over 100 social and environmental aspects. For its part, Fundação Telefônica Vivo has developed projects that adopt innovative methodologies in education training citizens ready for the challenges of the digital age. These initiatives benefited a combined total of 630,000 teachers and pupils. Another far-reaching social effort was the Pense Grande [Think Big] program, which encourages young people from low- income peripheral districts to become entrepreneurs. Some 3,500 young people were trained in 2016 and started projects