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Chunghwa Telecom Co. Ltd. (NYSE:CHT)

Q1 2011 Earnings Call

April 28, 2011 8:00 AM ET

Executives

Fu-fu Shen – Director, Investor Relations

Shyue-Ching Lu – Chairman and CEO

Shaio-Tung Chang – President

Yeh Shu – Chief Financial Officer

Analysts

May Lin – Yuanta

Ravi Sarathy – Citi

Joseph Quinn – Macquarie

Leping Huang – Nomura

Operator

Good evening, ladies and gentlemen. Welcome to Chunghwa Telecom Conference Call for the Company Q1 2011 Operating Result. During the presentation all lines will be in listen-only mode. When the briefing is finished direction for submitting your questions will be given in the question-and-answer section.

For your information, this conference call is now being broadcast 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 Investor section.

Now, I would like to turn it over to Fu-fu Shen, the Director of Investor Relations. Thank you, Ms. Shen, please go ahead.

Fu-fu Shen

Thank you. This is Fu-fu Shen, Investor Relations Director of Chunghwa Telecom. Welcome to our first quarter 2011 results conference call. Joining me today are – joining me on the call today are Dr. Lu, Chairman and CEO; Mr. Chang, President; and Dr. Yeh, CFO.

During today’s call management will discuss business operational and financial highlights for the first quarter 2011. This will be followed by Q&A. Before we continue, please note our Safe Harbor statement on slide one.

Now, I would like to turn the call over to Chairman, Lu.

Shyue-Ching Lu

Thank you, Fu-fu. Hello, everyone. This is Shyue-Ching Lu, Chairman of Chunghwa Telecom. Thank you all for joining our first quarter 2011 earnings results conference call. On slide number two, total consolidated revenue for the first quarter of 2011 amounted to NT$5.2 billion.

In addition to the increased fixed line revenue resulting from the shift in the pricing right of a fixed-to-mobile call from mobile operators to fixed Line operator, mobile VAS and handset sales were remaining as our key revenue drivers.

During the first quarter of 2011 we enjoyed persistent growth in our traditional telecom service business and continued to win additional ICT contracts. During the quarter we also continued to offer customers configured cloud computing services and to consolidate and repackage solutions.

Moving on to number -- slide number three, we remain committed to our shareholders, as you can see from this slide, which shows our cash return over the last several years. The NT$5.5243 cash dividend per share for 2010 operations results were approved by the board meeting in March and are subject to the final approval in the Annual General Shareholders Meeting scheduled for June 24 this year.

Total dividend payment is expected to be NT$42.9 billion. I would like to restate our commitment to maintaining our stable dividend payout policy.

Now, I will hand over to Dr. Yeh for our financial results.

Yeh Shu

Thank you, Chairman Lu, and good day, everyone. Thanks for joining us today. I will review our financial results in detail beginning with slide number five. Slide number five shows our income statement on a consolidated basis and provides a comparison on a year-over-year basis.

Our total revenue for the first quarter 2011 was NT$52.5 billion, a 5.8% increase, compared to 2010, primarily due to an increase of fixed line revenue resulting from the shift in the pricing right of a fixed-to-mobile call from mobile operators to fixed network operators.

Additionally, mobile VAS and the handset sales were areas of growth. Operating costs and expenses grew 10.9% to NT$38.5 billion, resulting a 6.1% decrease of income from operations to NT$13.9 billion.

Net income for the first quarter 2011 decreased 1.9% to NT$11.8 billion. EBITDA For the first quarter 2011 decreased 6.6% to NT$22 billion, mainly as a result of the negative impact on income from operations resulting from the shift in the pricing right of fixed-to-mobile call. The increase in costs of handsets sold and the early retirement expense.

Slide number six shows our revenue for each business segment for the first quarter of 2011. In the domestic fixed line business, local revenues increased by 24.3% year-over-year, mainly due to the shift of pricing right for fixed-to-mobile calls.

The 13.2% decline in DLD revenue was due to mobile and VoIP substitution, as well as reflecting the mandated tariff reduction.

Broadband access revenue, including ADSL and FTTx increased by 3% year-over-year, although ADSL access revenue decreased as more ADSL subscribers migrated to fiber solutions, the decrease was fully offset by growth in FTTx access revenue.

Mobile revenue increased by 2.8% year-over-year, mainly due to growth in mobile VAS revenue related to our smartphone promotion and handset sales.

Internet revenue rose by 3.6%, mainly due to Internet service growth, which was driven by the increase in broadband subscribers and the migration of ADSL subscriber to fiber solutions.

International fixed line revenue decreased by 4.5%, mainly due to the decrease in leased line revenue and satellite service revenue resulting from the expiration of ST-1 contract at the end of January 2011.

Slide seven shows the breakdown of operating costs and expenses. The increase in operating costs and expenses in the first quarter 2011 was mainly due to the increase in interconnection costs and transition fee resulting from the shift in the pricing right of fixed-to-mobile calls, the higher cost of handsets sold and the early retirement expenses.

As show on slide number eight, cash flow from operating activities was NT$9.7 billion during the first quarter of 2011. The decrease, compared to the same period last year was mainly because starting from 2011 the company brought its billing period for monthly fee in line with that for communication charge.

We were still in strong cash position on March 31, 2011, with cash and the cash dividend amounting to NT$75 billion.

Slide number nine shows the result of our first quarter 2011 operation as compared with our full year and first quarter guidance on unconsolidated basis. The performance of the first quarter 2011 is basically in line with the full year guidance.

Comparing with the first quarter guidance the higher net revenue mainly came from mobile VAS revenue and handset sales. The higher operating costs and expenses were because of the higher cost of handsets sold relevant to the popularity of smartphone.

Now, I will hand over to President, Chang for our business performance.

Shaio-Tung Chang

Thank you, Dr. Yeh. Now let me take you through our business performance. Slide 11 shows the results for our broadband services. By the end of March 2011 Chunghwa had about 4.4 million broadband subscribers.

Our strategy is to continue the migration to FTTx and offer differentiated services. We’ve seen continued success from the customer loyalty initiative we began in August 2010 to provide free speed upgrades for ADSL customers who were using lower speed services.

Our initiatives to encourage FTTx migration have yielded solid results, with FTTx subscribers as a percentage of total broadband subscribers increasing from 40.4% at the end of March 2010 to 48.1% at the end of March 2011.

In the first quarter of 2011 FTTx revenue reached 63.2% of total broadband access revenue. We also received a growth of 3.6% in Internet services revenue year-over-year.

Moving on to slide 12, which shows the recent boost we have seen from the MOD subscribers growth. Till April 15th, we’ve accumulated 840,000 subscribers. We’ve enjoyed steady growth in MOD revenue as a result of strengthening our MOD offering in terms of content, marketing and interactivity.

As increasing fiber coverage facilitates our capability to offer HD services to more customers, we will continue to offer additional popular HD channels to better cater to customer preference and enrich viewing experience.

Our target is to reach 1 million MOD subscribers by the end of 2011. With the approval the NCC gave us in January to help aggregator package quality channels for our MOD services. We expected continued introduction of new package with versatile content and therefore, anticipate a significant increase in MOD subscriptions and accompanying rise in relevant ARPU this year.

Turning to slide 13, by the end of March we continue to be Taiwan’s leading mobile operator, with the lowest churn rate and solid year-over-year subscriber growth of 3.9%, bringing the total number of subscriber to around 9.8 million at the end of March.

3G subscribers, as a percentage of the total has continued to increase and we expected to have 10 million mobile subscribers by end of this year. For the first quarter 2011 mobile VAS revenue increased by 38.6% year-over-year and now accounts for 20% of our mobile service revenue.

Mobile Internet showed the highest year-over-year growth of 88%, making it the highest contributor to VAS revenue. We expect continued growth in mobile VAS as we focus on executing our VAS strategy to enhance user experience and create value-added services.

We are integrating 3G and Wi-Fi network to improve network efficiency and facilitate VAS usage. We are on the track of Wi-Fi access points construction and are expecting to accumulate 20,000 Wi-Fi access points by the end of 2011.

Slide 14 shows the success of our mobile strategy. Our smartphones, which leverage a variety of applications are increasingly penetrating the premium customer segment.

Smartphones accounted for 39% of total handsets offered in the first quarter 2011 and we expect the penetration -- percentage to reach 35% to 45% depending on the market dynamics during 2011. As of March 31st mobile Internet subscribers, including mPro, data card and tablet users, had grown to 989,000, a 97% increase year-over-year. We anticipate that we’ll have 1.2 million mobile Internet subscribers by the end of this year.

On the ARPU side, you can see that smartphone ARPU is 108% higher than blended ARPU. Our comprehensive smartphone portfolio supports all mobile operating systems and spans most world-class brands, includes iPhone and HTC. And we have an MOU with HTC to form a strategic partnership, work together on customized handsets and the share marketing resources.

We have also been focusing on enriching content via customized value-added services with the launch last year of Hami Apps, which has over 2,000 applications and it supports the Android platform. We believe our efforts to enhance content will further expand our customer base and solidify our leading market position.

As shown on slide 16, overseas development is another future growth initiative for CHT. South East Asia and China are two major areas we are focusing on.

On ICT business, our joint venture with Viettel established the largest IDC in Vietnam and we initiated a joint venture, Sertech in Xiamen to capture growing local business ICT needs. We have established a wholly owned subsidiary in China and will establish another one in Vietnam to function as ICT-related solution providers and leverage our ICT competence.

Moreover, we signed an agreement and a Letter of Intent with China Telecom to exploit energy saving market opportunities and to capture cross-strait information development opportunities.

On Telecom business, through our subsidiaries in America, Hong Kong, Singapore and Japan, we provide quality competitive services, including international private leasing circuits, IP-VPN, IP transit, voice and data wholesale services, as well as type I and type II services to multinational corporate customers. Recently, we began to cooperate with China Unicom to help expand its distribution channels and enlarge mobile VAS business scale.

Turning to slide 17, I’d like to show you our CapEx plan, which remains prudent. Total CapEx for the first quarter 2011 amounted for NT$4.4 billion, a 5% increase compared to the same period in 2010. Of the NT$4.4 billion, 77% was used for the fixed and Internet business, 21% was spent on the mobile business and the rest went on other capital expenditure. We believe that this indicates a healthy level of CapEx for long-term sustainable growth.

Next is the regulatory update. We have five major regulatory updates to share with you, as show on slide 19. We have reported to you before the regulatory change on the mandated tariff reduction, the shift of fixed and mobile calls pricing right, the progress of the digital convergence related regulation and the extension of the 3G license. Please find more detail on this slide.

In addition to the former four regulatory updates, the NCC mandated us to submit a proposal by the third quarter of 2011 for combining island-wide telephone service tariffs into one local tariff. We are still in negotiation with the NCC about this proposal.

That’s all for our business operations. Now, I’ll hand it over to Dr. Lu to take you through our strategy. Thank you.

Shyue-Ching Lu

Thank you, President, Chang. Before entering into the last slide, let me add that President Chang skipped slide number 15 and let me say a few words about this page, new business initiatives for future growth.

We have been launching converged services to meet growing customer demand and the multi-screen services is expected to be available by the end of this year. Our development of ICT businesses are on track. We continued to gain contracts from corporate customers and expect revenue growth of 23% year-over-year for 2011.

Starting 2011, we are cooperating with domestic ICT-related associations and independent software vendors to seize the business opportunities from the growing Cloud Computing demand and are expecting to construct more than 12,000 virtual machines by the end of 2011.

With our experience, market leadership and continued investment in technology, Chunghwa is well positioned to further solidify its leading position as an information and communications service provider.

Now, please turn to page 21. Our business strategy and policy remains focused on pursuing growth by maintaining our operational focus on broadband, VAS, innovation and integration and enhancing cooperation with subsidiaries to expand our overseas business and enlarge the scale of our operations.

We will also accelerate network upgrades and integration, as well as taking advantage of industry alliances to develop market-leading products and services and capture new service opportunities.

To ensure, we maintain the high-quality human capital necessary to execute on our business strategy and policy. We endeavor to create an environment in which employees can achieve their maximum potential.

At the same time, we continue to implement stringent cost control initiatives to support the development of our business. Underscoring everything we do is our unwavering commitment to corporate social responsibility, which manifests itself in our continued efforts to enhance corporate citizenship.

Moreover, we would like to report to you that the ST-2 satellite we invested together with SingTel is going to be launched in mid of May this year to replace ST-1, which is about to retire. We will continue to provide quality satellite services to our customers.

That’s all for the presentation. We would like now to open up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is May Lin from Yuanta. Please begin.

May Lin – Yuanta

Hi. Thanks for taking my question. I have three questions here. First of all, we didn’t really talk about a capital management plan in the slides. Can you share with us if there is any possibility we will discuss another capital reduction this year, maybe announced later?

And my second question is about if we take off the regulation change, fixed-to-mobile pricing right change impact, can you share with us what’s the growth for mobile voice and local call revenue for the first quarter?

And my last question is about the regulation. As President Chang mentioned, we are still under negotiation with government about a single tariff for island-wide phone service. But can you share with us if there is any affirmation about a potential impact from this regulation change? Thanks.

Yeh Shu

For the capital reduction question, so far, we don’t have such plan. Okay. Thanks.

May Lin – Yuanta

Okay. Sorry, can I follow up? So maybe we won’t have the discussion this year, but in coming years, we will reconsider again maybe in next year? Is this right?

Yeh Shu

Yeah. It’s possible in the future. We will take into our investment needs of the cash and so on. So, but so far this year we don’t have a plan for capital reduction.

May Lin – Yuanta

Okay. Also can you share with us a bit about the rationale for this year? We cease the capital reduction consideration maybe for what kind of investment consideration et cetera?

Yeh Shu

We talk this before because the depreciation and the CapEx now is coming close and that is a source of the funding for the past capital reduction. And also we look next one or two years or maybe longer, there are some new investment needs. And so we have to think about whether we have the extra ability to do the capital reduction. Yeah. So our priority is to allocate the capital for the future business growth. Thanks.

May Lin – Yuanta

Yeah. Thanks. That’s really helpful. Okay.

Shyue-Ching Lu

Your next question about the fixed-to-mobile changes, the impact for total revenue is about NT$107 billion for the first quarter. But I have mentioned the first quarter is only two months. Thank you.

May Lin – Yuanta

Okay. Thank you.

Shyue-Ching Lu

As to the third question, still negotiating and until now we don’t have any further information about that. Thank you.

May Lin – Yuanta

Okay. Thanks.

Operator

May, do you have any further questions?

May Lin – Yuanta

No. Thank you very much.

Operator

(Operator Instructions) Our next question is Ravi Sarathy from Citi. Please go ahead.

Ravi Sarathy – Citi

Sure. It’s Ravi Sarathy from Citi in Hong Kong. Thank you very much for the opportunity to ask a question and congratulations on your results. I just want to make sure that I fully understood the discussion you just had on capital reduction.

My understanding from what you just said is that because of the fact that the gap between depreciation and CapEx isn’t wider for this year, you believe that there is not going to be a cap reduction for this year. Is my understanding correct?

Yeh Shu

So far, we don’t have a plan for capital reduction.

Ravi Sarathy – Citi

Okay. A quick follow-up question. In the previous years, last year, year before, at what point did you create your capital reduction plan? Was it usually later in the year or earlier in the year?

Yeh Shu

Usually, it’s around April.

Ravi Sarathy – Citi

Okay. Okay. Would it be fair to – so would it be fair to read from the discussion that it’s probably unlikely that there’ll be a capital reduction this year, or is it something which you still have to consider and discuss and come to a decision on?

Yeh Shu

I think, so far, we don’t have capital reduction plan. But in the future it might change. So that’s all what I can say, we don’t have a plan so far.

Ravi Sarathy – Citi

Understood. Thank you very much.

Operator

The next question is Joseph Quinn from Macquarie. Please go ahead.

Joseph Quinn – Macquarie

Thank you, I’ve got two questions. Sorry to ask again on the capital reduction, but can you go firstly into a little bit of detail in terms of the political pressure that was put upon Chunghwa in the fourth quarter of last year?

Does that really have any impact in terms of the decision that’s been made now, because it seems like this wasn’t an issue before really until we came into that sort of November, December timeframe?

And also on your business in terms of expanding out your Wi-Fi hotspots, you said you are targeting out to have 20,000 hotspots by the end of the year. Am I correct in thinking that in Taipei City they’re going to have a free Wi-Fi zone? I’m just wondering what the percentage of hotspots you have in the Taipei area will be and how that will be affected by that business change? Thank you.

Shyue-Ching Lu

Okay. Thank you. The restriction imposed by the Legislative (inaudible) is unrelated to the capital reduction, because the restriction is we -- if we propose some capital management plan, which would affect the percentage of government’s ownership, then we should report to a committee there.

Yeah, but capital reduction, as we did before, that won’t have effect on the percentage of government ownership, so our current -- so far, we don’t have any plan, is this simply because we are considering the cash flow and considering possible future investment. So we want to make sure we use the money wisely. Thanks.

Joseph Quinn – Macquarie

Sorry, just a follow up on that when you are talking about change in the percentage holding, I believe one of the issues as well that the Legislative Yuan had was the fact that they were concerned by reducing the capital that some time in the future Chunghwa would maybe need to increase their capital and that would, thus, decrease their percentage holding. Is that a related angle to that as well?

Shyue-Ching Lu

I think the concern of about raising capital in the future is not just a concern of the Legislative (inaudible). There are some shareholders, mainly the retail shareholders, they talk to us. They want us to think more about whether we can afford the capital reduction without a future capital raising because many of them would live on our dividend as for their retirement. So they are, kind of, want us to watch out of this issue. Okay. Thanks.

Joseph Quinn – Macquarie

Thank you.

Shyue-Ching Lu

About the Wi-Fi construction, as you know, the Taipei government has offered free Wi-Fi, but that’s quite different with ours. According to our information, the Taipei free Wi-Fi, it’s only of 512 KB/sec, but our Wi-Fi, the maximum speed we are up to 10 MB/sec. So that’s quite different.

And the second is, we are install our Wi-Fi over the public areas, for example, the convenient stores, hub, train stations and we try to find everywhere, even our public phone booths to install it. Thank you.

Joseph Quinn – Macquarie

Sorry, just to follow up on that. Will the Taipei government -- city government be using your current network installed or will they be using another enterprise network? I believe they used to backhaul on the Wi-Fi who’s now owned by Firestone. Will that still be the case or will Chunghwa have an opportunity to provide services there too?

Shyue-Ching Lu

Yeah. We are studying about this topic, but today I know the Taipei government uses WiMAX as their backhaul. Thank you.

Operator

Joseph, do you have any further questions?

Joseph Quinn – Macquarie

No. That’s fine. Thank you.

Operator

(Operator Instructions) Our next question is Leping Huang from Nomura. Please go ahead.

Leping Huang – Nomura

Thank you to take my questions. I have a question about your page 11 and 12 about these MOD and these broadband service development. Can you elaborate the – what’s the current competition environment in these broadband service after this cable a lot acquisition happened in last year? Especially, I notice that if we look the page 12, the MOD subscriber growth is quite low in this quarter and you want to achieve this 1 million MOD subscriber target.

Is it still possible for you and for the broadband ARPU whether this migration to the FTTH are mostly now and I think these two are linked MOD subscriber growth and FTTH are linked together? Thank you.

Shyue-Ching Lu

The broadband competition, the majority comes from the cable operators because they are using their systems to provide quite a lower tariff compared to ours. So what our strategy is? We upgrade our speed, we try to differentiate with them. Besides that, we also offer some value-added services, such as our music programs. So all our customers can enjoy our music programs.

Besides, we have -- we bundle our card service maybe on the, I think the first -- the second quarter, we will offer the card pack. We call it the card pack. That’s something like a drop box service to our -- every broadband customer. So that’s what we are doing that’s about broadband. As to the MOD, the first quarter, I think, your question is, let me…

Leping Huang – Nomura

Whether you can achieve your 1 million, I mean, you have this 1 KK subscriber target. It looks quite slow. I mean your MOD subscriber growth is quite low, so I was wondering this is also affected, this will also affect your FTTx migration due to the rising competition with the cable TV operator?

Shyue-Ching Lu

Regarding to the MOD subscribers’ targets for this year, we have set a relatively high goal of 1 million and the beginning of the year, you know, tends to be relatively slow, according to our experience and our sales teams are very much committed to gaining customers.

And from our operational results it’s indicated that the net-adds keep growing, especially in March as compared to February. And we still have, eight months to go. So, we believe we have a very high probability to achieve this target, okay. We will do our best.

The -- because we emphasize on high quality, especially HD service through our MOD offering, fiber solution is very important and we -- while we are gaining, attracting customers on MOD, we deploy further the coverage of FTTx solutions. So this goes hand-in-hand and we believe we will be able to achieve it. And the ARPU from MOD is also increasing from time to time and so, it’s moving into the right direction here.

Leping Huang – Nomura

Okay. Thank you.

Operator

(Operator Instructions) If there are no further questions, I will turn back to Chairman, Lu.

Shyue-Ching Lu

Well, thank you very much for joining our conference call for the first quarter of this year’s operating results. Thank you very much. Goodnight from Taipei.

Operator

Thank you, Chairman, Lu. Thank you for your participation in Chunghwa Telecom conference. There will be a webcast replay within an hour. Please visit www.cht.com.tw/ir under the Investor section. You may now disconnect and goodbye.

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