Chunghwa Telecom Co Ltd Q2 FY2020 Earnings Call

Good afternoon, ladies and gentlemen. Welcome to Chunghwa Telecom Conference Call for the Company's Second Quarter 2020 Operating Results. For information, this conference call is now being broadcasted live over the Internet. Webcast replay will be available within an hour after the conference is finished. Please visit www.cht.com.tw/ir under the IR calendar section. Now I want to turn it over to Ms. Angela Tsai, the Director of Investor Relations. Ms. Tsai, please go ahead.

Thank you, operator. Hello, everyone. Welcome to our second quarter of 2020 results conference call. This is Angela Tsai, the Director of Investor Relations for Chunghwa Telecom. During today's call, Mr. Harrison Kuo, our President and Chief Financial Officer, will provide an overview of our business achievements during the quarter and discuss operating highlights. He will be followed by Ms. Fu-Fu Shen, our Assistant Vice President of Public Affairs, who will provide financial highlights. We'll also have a Q&A session. Now I would like to hand the call over to President Kuo, and please note your safe harbor statement on slide two. President Kuo, please go ahead.

Thank you, Angela, and hello, everyone. Welcome to our second quarter 2020 earnings call. Today, I would like to begin by highlighting our 5G service launch, which took place on June 30. We expect the launch of 5G service to transform the mobile market toward sales growth. So far, we have seen evidence of a significant increase in adoption of our high-priced mobile plan amid the 5G launch. We believe 5G is a chance for telecom operators to provide services beyond that of standard operators by delivering services while protecting our business model. We will actively create innovative 5G services by acquiring, building or collaborating with partners from different verticals. In addition, we aim to provide a broadband connection environment to satisfy customers. We believe our advantage of the largest mobile broadband spectrum can enhance network infrastructure and the availability of WiFi are the key reasons for us to excel. Now I will provide the key highlights of the second quarter of 2020. I am pleased to say our 300 megabits per second broadband migration increased more than 30% year-over-year in the second quarter. Our vertical private network service offerings provided through enterprise customers continued to grow and contributed to total revenue. In addition, our at-home WiFi subscriptions increased 120% year-over-year. We are pleased to see the healthy growth of our core business. During the quarter, we also continued to see the impact of the COVID-19 pandemic on our overall business. We witnessed the growth in fixed broadband, cloud and ICT services due to increased demand for work and study from home, and the multi-business was relatively resilient, thanks to the growing stay-at-home lifestyle trend. In addition, digital channel assets and transactions increased 92% year-over-year, enhancing our overall channel funding and performance. However, international mobile enrollment revenue continues to be affected due to the ongoing lockdown, and we expect this trend will continue over the next several quarters. Now allow me to walk you through each of our baseline slides. On slide five is an update of our mobile business. We are pleased with our continued leadership in both mobile revenue and subscriber numbers during the quarter. In addition, we are encouraged by our postpaid subscriber number, which has been increasing for six months in a row, showing our success in both existing subscriber retention and new subscriber acquisition, especially from the effective growth initiatives. In overall mobile performance, we are pleased to continue to experience a small decrease in mobile service revenue among our peers quarter-over-quarter. This was mainly due to our efforts to guide subscribers towards adopting higher priced plans. Slide six provides an introduction of 5G services. As the largest 5G spectrum holder in Taiwan, we anticipate offering our customers quality 5G services with cloud gaming, Ultra HD video streaming, and VR or AR-related applications at the highest speeds and with low latency. We aim to acquire more than one million 5G subscribers over the next year. In addition to retail consumers, we will also leverage our 5G network to support innovations from enterprises, making connections for applications such as smart importation, medical applications, smart inspection, and other vertical applications. We value our large enterprise customer base and expect the percentage of revenue contributed by enterprise in the 5G era to grow in the medium term. Slide seven shows our SG&A network construction plan over the next two years. As of June 30, when we launched our 5G service, more than 2,000 base stations covered all cities and counties in Taiwan. We provide 5G service on the 2.1 gigahertz and 3.5 gigahertz bands. By leveraging 5G, our 4G networks and 4CA application enhancement, we are confident that we will be a frontrunner in Taiwan in terms of 5G speed and coverage. By the end of this year, we plan to complete more than 4,000 base stations to ensure 5G coverage in major metropolitan cities and important transportation hubs along high-speed rail and the main lines. By 2020, more than 8,500 base stations are expected to further expand coverage nationwide. The key 5G rate is expected to reach two gigabits per second, with support from 5G and our 4G network and 5CA acquisition technology. Please turn to slide eight for an update on our broadband business in the second quarter. During the quarter, we are encouraged by the continued ARPU increase in our broadband business, which reflects our success in migrating subscribers to adopt higher speed services. The number of subscribers signing up for the 300 megabits per second or higher increased by 81% year-over-year amid the growing VPN revenue contribution from enterprise customers. We are confident in overall business growth, even though the number of lower speed subscribers continues to decrease quarter-over-quarter. Slide nine demonstrates our MOD business performance. In the second quarter of 2020, our IPTV and multi-platform continued to be the largest video platform in Taiwan with more than 2.08 million subscribers. Despite the delay of the 2020 Tokyo Olympic games, which decelerated subscription momentum, overall MOD revenue continued to increase 2.1% year-over-year, mainly from the increase in VOD revenue. Although our SVOD subscription number decreased year-over-year due to program adjustments made during the quarter, we continue to see that our tier pricing channel packages are the most popular. Going forward, we believe our IPTV MOD platform, which carries VOD channels and OTT services, will remain relatively resilient as the cable market is being re-opened to OTT and strengthened by low-priced competition. Please turn to slide 10 for our ICT business update. In the second quarter of 2020, overall ICT project revenue increased 3.8% year-over-year, mainly due to revenue recognition of some large projects and the increase in mobile ICT revenue. Because the COVID-19 pandemic continues to affect enterprise consumers and customers' business decisions, we will closely monitor business opportunities in the enterprise market and aim to enhance ICT training revenue contributions to stabilize overall ICT business performance. In terms of emerging ICT business and services, in the second quarter of 2020, ICT revenues increased 4.2% year-over-year, and information security revenue increased 30.7% year-over-year. Cloud revenue decreased 15.8% year-over-year due to a higher base of project revenue in the second quarter of last year. However, we are glad to see that cloud streaming revenue continues to grow year-over-year. To maintain our leading position in this emerging service, we will continue to collaborate with our subsidiaries and departments to expand market share and profitability to strengthen overall performance. At this point, I would like to turn the call over to Fu-Fu to review our financial results.

Thank you, President Kuo. Now I will go through our financial results in greater detail. I will begin with slide 12, which provides highlights from our income statement. For the second quarter of 2020 on a year-over-year basis, total revenues decreased by 4.6%, while operating costs decreased by 6.6%. Income from operations increased by 3%, and net income remained the same year-over-year. In addition, our EBITDA margin increased to 40.5% from 38.1% in the same period of 2019. Please refer to slide 13 for revenue breakdown by business segment. The decrease in total revenue for the second quarter of 2020 was mainly due to the decrease in fixed voice revenue, paper sales revenue, and mobile service revenue. The decreases were partially offset by increases in other revenues contributed by our subsidiary through our precision test. Moving on to slide 14. Our operating costs decreased by TWD2.61 billion, or 6.6% year-over-year in the second quarter, mainly due to lower interconnection costs, cost of goods sold, and maintenance materials. Slide 15 shows that cash flow from operating activities for the second quarter of 2020 decreased by TWD2.78 billion, or 17.5% compared to the same period of 2019. This was mainly due to an increase in accounts receivable. As of June 30, 2020, we had TWD19.17 billion of cash and cash equivalents, a decrease of TWD17.38 billion or 47.6% compared to the same period of 2019. The decrease was mainly attributable to the payment of transition fees for the 5G frequency spectrum option, which was partially offset by an increase in short-term. Slide 16 shows our operating results as compared to our guidance. In the second quarter of 2020, revenue was lower than guidance, mainly due to lower handset sales and mobile service revenue. On the other hand, our operating income, net income, and EPS exceeded guidance. Lastly, slide 17, we are budgeting CapEx of TWD30.7 billion for 2020 as we started 5G service on June 30. 5G-related CapEx has been spent and will be executed according to our plan. We will also continue to focus on our CapEx spending on our growing and emerging businesses to enhance overall performance. Thank you for your time. We would now like to open the line for questions.

Our first question is from Neale Anderson from HSBC. Please go ahead.

Hi guys, good afternoon, I have two questions, please. The first relates to the cost outlook. Because I see marketing expenses have been coming down, I think, down by about 4%. How do you expect that to trend now that 5G has been launched and if we go into the second half with more 5G handsets? So really, that's my first question about the cost impact of 5G and whether you can take costs out to offset that? And then the second question was really, could you give us an update on mobile competition? Has there been any big change in the quarter? What you see the outlook is?

For your first question about entering the second half, regarding 5G related marketing expenses. First, we understand that since we would like to see the 5G migration speed up a little bit in the second half. With the encouraging resources, we allocate all our resources. For example, the handset subsidies amount in 4G and 5G, we will set aside a little volume for 5G. Thus, of course, for marketing, we will spend a bit more on 5G. So in the transition from the second quarter into the second half, that part will increase for sure. The second question, would you repeat that?

Sure. It's really on the general state of mobile competition. Have there been any changes? Have you seen any price changes in the market?

Actually, I think all three major competitors have already launched 5G services. The business is still in a very early stage. For 4G, the competition has been quite stable. So I would say that the overall mobile competition is relatively stable. We don't see any big changes in this quarter.

Thanks, sir. And thank you.

The next question is coming from James Wang from UBS. Please go ahead.

Good afternoon. I just got a really quick question. I just wanted to find out for those customers that are taking up 5G plans. What sort of increase are you seeing on the ARPU? Or are they mostly high-value customers that are moving in parallel in terms of ARPU to 5G?

Sorry, can you repeat your question? It's not very clear.

Yes. So I just wanted to know whether you are seeing any ARPU improvement for those customers that are taking up the 5G plan.

Yes, the ARPU for the 5G bundles is higher than 4G. In the past several months, we've been working through our civil service program, and it has gone very smoothly. We're quite happy with the results; more than 90% of our test program participants have signed contracts, and we see overall positive results. We're looking to replicate these results in our upcoming packages which are to be completed by November this year. We also have been performing well with our student packages. Although overall ARPU has seen some downward pressure in different sectors, we continue to work hard to upsell. We anticipate that as the 5G migration accelerates, we expect ARPU uplift in the future. Of course, this may not be immediate, but we definitely see potential.

Okay. Thank you.

And the next question is coming from Amber Lee from Yuanta. Go ahead please.

Two questions here. First, you're guiding TWD50 billion of CapEx for this year with your target of building out 4,000 base stations by the end of the year and for next year, if you're expecting more than 8,500 base stations, should we expect to see a significant increase in your CapEx for 2021? That's my first question. And secondly, can we have a ballpark on the initial adoption rate of 5G plans? Whether it's percentage-wise or as a number of subscribers.

4,000 base stations by the end of this year, and over 10,000 base stations in three years. We are confident regarding the number of base stations, and we do not overemphasize but rather meet customer needs and provide a good experience.

With the expected significant increase in CapEx for next year, will we see a more flattish trend?

Could you repeat your second question? It's not really clear.

That was a follow-up for my first question because it's related to the CapEx outlook for the next year. And then second, is the ballpark number of 5G subscribers, either percentage-wise or the number of subscribers for the initial adoption since the 5G service of Chunghwa has launched for about a month now. Just want to see the initial adoption trend?

I guess your question is related to the CapEx increase with the number of base stations. Yes, we have actually budgeted the CapEx for the ongoing base station build-out for the next several years. This is in order to accommodate customer demand and ensure quality service.

Then can we have the number of 5G subscribers in percentage?

The adoption rate of 5G or coverage is still in the very early stage. Sorry, but we will not disclose that number.

Thank you.

Okay, thank you.

Our next question is from Peter Milliken at Deutsche Bank. Please go ahead.

Thank you. I have just one question. Your net profit is about 5% ahead of what you expected it to be. Is there not one main reason for that? Would it be that marketing costs came in low? Or is there something else that's driving the better-than-expected performance?

I think the increase in margin, of course, must be viewed in the context of revenue. In the second quarter, our revenue actually decreased, particularly from handset sales, which is low-margin revenue. The international core revenue, also being low-margin, decreased. This kind of revenue increase, which actually brought a lot of costs down, resulting in better margins. Thus, this could explain why we see good margins for the second quarter.

I can see that revenue and cost went down because you were selling fewer handsets. But would that explain why profit was higher than expected? Or was service revenue?

No, I think the healthy sales were lower because of the border lockdown, so the international call revenues were also lower. This type of revenue is usually low-margin and related to heavy costs. Thus, when the overall heavy costs decrease, the margins improve. I hope this answers your question.

Yes, that’s fine. Thank you.

Okay. Thank you.

The next question is coming from an unidentified speaker.

I have two questions. First, can you compare the average payment of those new 5G subscribers to their original payment? We know the first quarter may have had a very high payment contributor from the 4G period. So can you compare their monthly payment in 5G now? And the second question is, we see the subscriber count of your MOD has been flat, slightly above two million subscribers for several quarters, while the subscribers of VOD saw a significant decline this quarter. However, we see that your broadband business revenue has slightly climbed these past few quarters. Does this mean that your MOD business has had some impact from competition, such as from Netflix or other services?

For your first question about MOD, you are asking if our 5G customers' ARPU is higher compared to the ARPU of 4G customers, correct?

Yes.

Yes, we definitely see an uplift. We are encouraged by that. Regarding your second question about MOD, yes, our MOD customer base continues to be somewhat stable, but it has dropped slightly. This is because we've been lacking major sports events over the last two years. However, we are happy to see that last year, we initiated tiered channel selections in our programming, allowing us to upsell some programs. Therefore, we see an increase in overall MOD revenue even though there has been some customer loss. The overall business has not been significantly impacted, and at the same time, while OTT services have some impact on our SVOD, we still see an opportunity to gain share. We are fortunate that we have integrated OTT services like Netflix into our platform. Overall, I believe MOD is much more resilient compared to traditional cable services in Taiwan.

Okay, thank you.

Thank you.

The next question is coming from Billy Lee from Credit Suisse. Go ahead please.

Thank you. Just to follow up on the previous answers regarding operating costs, particularly, I guess you are seeing that lower handset COGS and other product costs have decreased because of lower sales. But when I look at page 14, the operating cost is down 7.6%. So my question is, is that containing the majority of the items you just mentioned?

Our operating costs and expenses decreased about 6.7% year-over-year in the second quarter, mainly due to lower interconnection costs, cost of goods sold, and as you noted, handset sales decreased, along with maintenance and material expenses. Those are the three major items leading to the decrease.

Got it. And then another follow-up on previous questions regarding CapEx, particularly for 2021. I know that the CapEx guidance is not available for next year, but could you just give us the projection of the CapEx for next year? I think, given the increase in base station numbers, it's evident there will be a significant jump in CapEx.

In the 5G stage, the non-standalone architecture will be interoperable with 5G networks, and we will collocate the low, medium, and high bands to expand our 5G coverage year by year. We expect our 5G CapEx to peak between 2020 and 2023.

I'm sorry, can you repeat your last comment about 2021? I didn't catch that.

The 5G spending peak will be located between 2021 and 2023. Yes, I would like to clarify that.

Thank you.

The next question is from Amber Lee from Yuanta. Go ahead please.

With the margin in the first quarter being higher than guidance, do you expect...

Could you bring your microphone a bit closer? It's not really clear.

Okay, sure. Can you give us your margin outlook for the second half of the year, considering the 5G launch and potential marketing expenses?

Yes, please refer to our forecast announced at the beginning of the year. In the second half, amortization costs will increase because of the 5G launch, so it might be a little lower than the first half of this year.

That EBITDA margin?

Yes.

Just a little bit lower.

When we announced our divisional forecast early this year, we already factored in the 5G costs and all these factors.

So, is the upside from the first half of the year expected to offset in the second half of the year?

Sorry, it's not really clear. Could you clarify your question?

With margins being higher than your guidance in the first half of the year, do you expect it to also be higher than the guidance for the second half of the year?

We won't change our guidance at the moment.

Yes, thank you.

No further questions. Thank you.

The next question is coming from Billy Lee from Credit Suisse. Please go ahead.

Can I ask another question too? I know what are the most exciting new 5G application trends. I just want to get a sense of any potential huge 5G opportunities are coming up and whether we're seeing very good traction so far?

Everything is still in the early stages; nothing especially exciting at the moment. We are still cultivating user behavior.

No problem. Thank you.

Thank you.

The next question is from Jeff Chin from CHT Security. Please go ahead.

I have a question about whether we will change our forecast due to the treatment rate being about 40%. Are we adjusting our full year expectations or will we maintain them?

Yes, our forecast EBITDA margin is between 37%.

The achievement rate is only 40%, especially given the circumstances. Should we change our full-year expectations or maintain them?

No, we won't change our full-year forecast. As you know, the 5G rollout beginning in the second half will introduce healthy fees and marketing expenses. Margin improvements are expected for the second half and we will maintain our original forecast.

Okay. So another question is about when we will see the new iPhone. According to the plan, will we launch the new iPhone in the fourth quarter or is it so-called that we can have a new iPhone, especially the 5G new iPhone?

I think we need to wait for Apple to confirm that. Thank you.

If there are no further questions, I will turn it back over to President Kuo. Go ahead, please.

Thank you for your participation. Goodbye, everyone. Thank you.

Thank you. Thank you, President Kuo. Thank you for your participation in Chunghwa Telecom's conference. There will be a webcast replay within an hour. Please visit www.cht.com.tw/IR under the IR Calendar section. You may now disconnect. Goodbye.