NTT DoCoMo, Inc. (NYSE:DCM)
F3Q13 Earnings Call
October 26, 2012 4:00 AM ET
Kazunori Yamamoto – Managing Director, IR
Kaoru Kato – President and CEO
Fumio Iwasaki – SVP
Hirotaka Sato – Managing Director, Accounts and Finance Department
Kazuto Tsubouchi – SVP and CFO
Daisaku Masuno – Nomura Securities
Tetsuro Tsusaka – Morgan Stanley
Hiroshi Yamashina – BNP Paribas
Hitoshi Hayakawa – Credit Suisse
Yoshiyuki Kinoshita – Merrill Lynch
Thank you very much for waiting. And thank you very much for attending this press conference despite your busy schedule. We would now like to commence NTT DOCOMO’s Analyst Meeting announcing the Results for the First Half of the Fiscal Year Ending March 2013. I am Yamamoto of the IR department, and I will be serving as emcee for this meeting.
Please be advised that this session is broadcast via live service on telephones as well as the Internet. And also, a recorded video of this meeting will be provided through DOCOMO’s website for on-demand distribution.
Now, I would like to introduce to you the participants from NTT DOCOMO. We have Mr. Kaoru Kato, President and CEO; Senior Executive Vice President, Mr. Kazuto Tsubouchi; Senior Executive Vice President, Fumio Iwasaki; Executive Vice President responsible for consumer marketing, Mr. Takashi Tanaka; Executive Vice President and Managing Director of Corporate Planning and Strategy Department, Mr. Kazuhiro Yoshizawa; Senior Vice President and Managing Director of Finance and Accounts department, Mr. Hirotaka Sato.
For today’s meeting, we will be using three sets of documents which are distributed to you; the earnings release, the presentation slides, as well as the press release. Please confirm that you have full set of documents.
For today’s meeting, we would like to start with a presentation from Mr. Kaoru Kato based on the presentation slides, which comprises three parts. First, the financial results; number two, DOCOMO’s competition strategy; and number three, future business management. After the presentation, we would like to entertain your questions and we would like to finish the meeting by 6 o’clock.
Please also be advised that the comments made during this meeting, during the – also including the Q&A session may contain forward-looking statements, and please refer to the slide or the Form 20-F filed with the SEC regarding potential risks.
Now, without further ado, I would like to have Mr. Kato. Please start the presentation.
Good afternoon to you and thank you very much for attending this conference despite your busy schedule. I would now like to start the presentation regarding the financial results. The presentation consists of three points or three parts, and there might be some points that I might skip.
So let me first start from slide number three, the highlights of the first half results. Operating revenues reached ¥2,207.3 billion, which is ¥94.3 billion or 4.5% higher compared to the same period last fiscal year. Operating income was ¥471.1 billion, down ¥37.4 billion or 7.4% year-on-year. Operating income reduced; however, operating revenues have recorded a stable increase.
Regarding the concrete results, total handset sales increased by 14% year-on-year and reached 11.84 million units, making a favorable progress. Especially, the smartphone sales was quite brisk. We sold 6.44 million units, up 77.6% year-on-year for the first half. Our Xi subscribers has been increasing at a faster pace than expected and the total number of subscription was 6.2 million as of the end of September, up 178.6% compared to March 2012. And the smartphone user base has been expanding and which resulted in an increase of packet revenues of 7.6% year-on-year, which reached ¥975.6 billion for the first half.
Slide number four, the selected financial data. I’ve already commented on the operating revenues and operating income. Free cash flow, as you can see there, decreased by ¥216.6 billion year-on-year. This was mainly due to the increase of subscribers purchasing handsets based on installments that was the major reason. And also because of the facility buildup for the Xi LTE network.
Slide number five, the factors behind year-on-year changes in operating income. As you can see on the left-hand side, the orange part represents the operating revenues changes and the green part are the expenses. Voice revenues excluding the impact of billing – monthly support, decreased by ¥80.8 billion due mainly to the reduction in billable MOU. Packet revenues increased by ¥87.9 billion due to the stepped up efforts to sell smartphones and Xi-enabled devices.
The third box represents the impact of monthly support discounts, which accounted for a decline of ¥71.8 billion. Other revenues increased by ¥31.9 billion due mainly to the increased subscription to the mobile phone protection delivery service and the revenue contribution from subsidiaries. Equipment sales revenues increased by ¥127.2 billion due mainly to the increase in the number of handsets sold.
The green parts on the right, equipment sales expenses on the flip side of the revenues increased by ¥64.4 billion and other expenses also increased due to the increased sales by the subsidiaries. Other expenses increased by ¥67.4 billion. So, all together, if we subtract these expenses from the revenues, operating income decreased by ¥37.4 billion year-on-year.
Now let me give you some numbers. The handset sales for the second quarter, as you see from the middle box there, was 6.67 million units. So if you combine the first quarter results, altogether in the first half, we sold 11.84 million units, which is making a very favorable progress towards our full year target of 23.8 million units. The first half sales increased by 14.4% and the new sales also increased by approximately 16%. We will leverage the winter collection and promote the sales of Xi and smartphones going forward.
Slide number seven. The total handset sales of smartphones for the first half was 6.44 million units, which is 74% higher compared to the last fiscal year. The second quarter sales was 3.95 million units. We believe the smartphone user base will be the main driver for our growth going forward. So we believe it is very important that we increase the number of smartphone users in order to boost our packet revenues.
So compared against initial plan of selling 13 million units for the full year, we made an upward revision. So the new forecast is 14 million sales of smartphones for the full year. And if you look at these bars, the Xi percentage are represented there. In the second quarter, 70% of these sales was achieved by Xi phones and the percentage is likely to increase going forward.
Page nine shows the market share of smartphones sold at mass retailers on a quarterly basis. In the second quarter, we controlled a market share of 55% of the smartphones sold at mass retailers. So our smartphone lineups centered on Android devices, I think are achieving sales that are not inferior to the competition.
Slide number 10, regarding the – slide number nine, the packet revenues. Leveraging smartphones, especially the Xi devices, we’ve been able to achieve an increase in packet revenues, which has been reporting a remarkable increase and the first – second quarter packet revenues was ¥490.5 billion.
Number portability performance; as you can see there, this compares the performance on a quarterly basis for the first two quarters on a year-on-year basis. As you can see here, we have been striving and we succeeded in increasing the number of port-ins, but on the other hand, port-outs has also increased. The total handset sales and new sales are comparable to the competition as I said earlier.
Slide number 11. We revised our full year results forecast. For business management in the second half onwards, as I mentioned earlier, the expansion of user base of smartphone is the number one priority, because this will boost our packet revenues in the mobile business for the short term and also over the medium term because we have a plan to offer new services such as cloud services and the user base will form the foundation for this business and therefore we believe this is of utmost importance.
So under this philosophy, as I said earlier, we have made upward revision to our full year smartphone sales forecast from previously 13 million to the new – to 14 million in the new forecast. Accordingly, operating revenues are expected increase by ¥70 billion compared to the initial plan to ¥4,520 billion.
So in order to achieve this, we need to boost our competitiveness and we would love to expand our smartphone user base as expeditiously as possible. And to achieve this, we decided to spend an additional ¥80 billion of expenses in order to boost our competitiveness and achieve an increase in smartphone users.
Therefore, the initial operating income forecast of ¥900 billion was revised downwards to ¥820 billion in the new forecast. Of course, this reduce includes the impact of number portability. Especially because of the intensified competition for number portability for subscribers, we have been falling short of the acquisition of net additions. So this impact has been included, but we will try to offset that impact by improving our cost efficiency.
Capital expenditures, as I announced at the time of the new product announcement, we will be bringing forward a plan for LTE coverage expansion, so total CapEx was revised upwards to ¥749 billion. And on the other hand, we will make an all-out effort to improve cost efficiency.
The net income attributable to NTT DOCOMO after the new revision was revised downwards by ¥50 billion. So the new forecast is ¥507 billion, but that’s still higher or 9.3% higher compared to the figure for last fiscal year.
So that was about the financial result. Next I would like to comment on the new competition strategy for NTT DOCOMO. Some of them are the recaps of what I’ve been explaining before. As we have stated from before, DOCOMO cloud services and network services, mainly the Xi network and the handset lineup. These are the three major pillars for us to boost our competitiveness.
Page 14, the handset lineup. The model on the left is Galaxy S3. In just three months, after the launch, we have sold more than 800,000 units of them. And this is a global device and still it is equipped with many features that are highly sought by Japanese users as you see in the bottom.
On the right hand side, we have the Raku-Raku smartphone. We’ve already sold more than 300,000 units in three months. A lot of customization is made so – and these are well received by Japanese users. As we have announced during the product announcement meeting, all of our winter collection models are Xi enabled and these have five distinct features, which are self-explanatory.
Moving on to the next topic, I would like to talk about the further evolution of Xi service. As we have announced the other day, initially – our initial plan was to achieve 70% population coverage by March, but we have expanded – brought forward a plan to achieve 75% by the end of March and we will be offering 100 megabit per second downlink speed within this fiscal year. And we’ll be building 23,000 base stations by March, and we’ve already achieved 100% population coverage in the ordinance-designated cities.
Regarding the Xi subscriptions, as at the end of the second quarter, we had 6.2 million subscribers and the growth is faster than our expectations. And more than 70% of our handset sales are achieved through Xi devices. So we believe the total number of Xi subscriptions will reach 11 million by the end of the fiscal year. We initially had a medium term plan to achieve 30 million subscribers by fiscal 2015, but we made a huge upward revision to 41 million by fiscal 2015.
Xi Talk 24 is the 24-hour flat rate voice plan for ¥700 a month and more than 70% of customers are joining this service lately. And as of the end of the second quarter, a total of 3 million subscribers had joined this service, and we believe this will reach 6 million by the end of the fiscal year.
This is a new chart on page 20. We set our threshold at 3-gigabyte for the light package and the 7-gigabyte for the ordinary package. And this chart shows the number of users who have usage in excess of these thresholds. 23% of the 3-gigabyte users are using in excess of this threshold and their percentage is increasing.
Next slide, please, regarding DOCOMO cloud. As we have mentioned this on a number of occasions, in order for us to provide innovative services such as dmarket and intelligent services and storage services, we believe it is important to have a solid platform, which is the DOCOMO ID authentication platform for personal authentication and billing, and also a personalization platform for personal data. This will allow us to offer storage service, multi-device support, multi-platform support and big utilization of big data.
The intelligent service storage and dmarket, as far as dmarket is concerned, we’ve already launched our digital content in various stores. And we will further expand this by looking into the linkage with TV services.
As far as the intelligent services are concerned, we are already offering the Shabette Concier voice agent function, and as well as many translation services. This is the sort of natural cloud services that we’ve been mentioning before. For storage service, we have photo collection as well as the cloud storage of phonebook and mail service. And leveraging this state-of-the-art service development capability, we would like to generate new revenue sources.
dmarket; as we announced during the new product unveil session, digital content, physical merchandise and life support services are the main pillars here. For digital content, we are going to embark on gaming service. And for physical service, we will be offering shopping site, and we will also be shortly introducing various education and healthcare services as part of our lifestyle support services. And Shabette Concier, on the upper left, will allow users to search these functions and activate these many services through voice commands.
Next, dgame. As I mentioned earlier, we’ve allied with nine different gaming players, and our target is to increase the revenues to ¥15 billion in two years’ time with a user base of 10 million. And this will be a carrier-free multi-carrier service.
Next is dshopping. You might have seen this earlier, but we have already begun in the red light – the red-colored part. We’ll be expanding this to blue as well as to the green color. So we are carrying our activities, and we want to achieve ¥20 billion in two years time.
Now already among this VIDEO Store has been launched. So let me talk about some actual cases. And also in conjunction with the chart on the top let me talk about based on cloud, DOCOMO cloud, we will be able to expand entry into the cloud environment. We have already 1 million after five months and we believe that we’ll have 2.8 million by the end of October and we’ll have 4 million by the end of this fiscal year. And so ¥25 per month on a full year basis, then we will have achieved ¥25 billion level of revenue from this category of service.
Next is the ANIME Store, it’s a niche. We are seeking 300,000 subscribers. We have 100,000 at this moment. This will translate to ¥400.5 billion worth of revenue eventually.
Next is dmarket revenue growth. We believe that we’ll be able to achieve ¥20 billion at the end of this fiscal year. So this is up – we have made an upward revision of sorts. And by the end of fiscal year 2015, we hope to achieve ¥100 billion from this market.
Next is the intelligence service, Shabette Concier. We have the character, again changed to a Chibi Maruko-Chan, Hello Kitty and Nomi Watanabe. So this – we hope to provide even larger number of characters.
Now this was already announced, but at CEATEC Japan, we won the grand prize. So we have achieved high ranking for this service. So as far as this is concerned, we hope to further enrich the lineup. And we hope to provide this in conjunction with the physical services in the case of Hanashite Hon’yaku speech translation services, as well as Utsushite Hon’yaku translation services based on text recognition technology.
And so I would like to talk about the competitive strategy based on DOCOMO cloud. I’ve talked about the services available in cloud. But as far as business management is concerned, we hope to (inaudible) the expansion of new business area in the light of future business and management. We talk about integrated service company.
We received questions that this was not very clear, so therefore, with that being the case, based on the one year track record, let me talk about what we want to pursue as well as our new business going forward.
Now we have the market injection phase and growth phase. And we’ve decided to highlight eight major areas of priority for us in this circle. Naturally, in the case of harvesting phase, we are focused on mobile. But we have five services in market injection phase and also three phases in growth phase. Finance payment, commerce, and media and content. I talk about the market ¥100 billion from that. So a great deal of that is in the media content category.
Next. So target revenues from new business. I mentioned ¥1 trillion in the previous year, but we have given you a more detailed breakdown. Media/content, commerce and finance management, these three major circles account for the bulk of this ¥1 trillion. But – and this is clear, we will have achieved ¥130 billion close – and more than half, and we hope that we’ll be able to pursue both organic growth as well as strategic alliance and seek ¥1 trillion. We believe this is fairly firm target for us.
Next is media and content business, one of the three major pillars. We believe that we’ll have ¥90 billion by the end of this fiscal year and ¥40 billion at the beginning of this fiscal year, so about fiscal 2015 we should have ¥300 billion.
Next is our commerce business. We believe we’ll have ¥120 billion at the end of this year. We have ¥45 billion as we speak, but this should grow to ¥300 billion by fiscal year 2015.
Next finance and payment business. We have already achieved certain level and we believe that we’ll have already ¥200 billion by the end of this fiscal year. Just as far as the growth is concerned, it’s not as much as the other two pillars; however, it should grow to ¥250 billion by the end of 2015.
Next is global revenues from new businesses. I talked about the eight major priorities and so we have extrapolated the global business portion out of that. By the end of this fiscal year, we should have ¥40 billion. It’s not very large at this moment. However, we want to increase this to ¥20 billion by the end of fiscal year 2015. And actually, we will be seeking organic growth and also we will have in mind the possibility of M&A as we expand the global revenue from new businesses.
Now let me change the topic. So these new businesses will focus both on acquisition as well as strategic acquisitions. Now this is part of the press release. We are going to be setting up the so-called DOCOMO Innovation Fund. And also DOCOMO Innovation Village we’ll be seeking incubation. We want to create a forum whereby we can and also grow the very seeds. And if we go into ventures, then we hope that from this fund we’ll be able to invest. And once they become venture companies, then we would like to invest. The fund is going to be in the order of ¥10 billion. I know that other companies are already doing this type of fund.
But as a company focused on B2C model, we want to be able to address this. Naturally, we are focused ultimately on dmarket and also DOCOMO cloud. We hope that this will be the destination of these various ventures and activities. So creating new services should come from this type of initiative. And we hope that we’ll be able to make contribution toward creation of new services and hope that this will resolve – reach realized results.
Next, let me talk about the definition of smart ARPU as I talk about a new growth indicator. Well, service integrated company and also mobile core. What we have done is divide between the new businesses and mobile business. The one in the blue, which is at the center, is already covered by the ARPU today. Packet ARPU already includes i-channel, i-concier, map navigation and the voice ARPU naturally is for voice revenue.
But as a new concept, we are going to be introducing smart ARPU. Voice ARPU will remain voice ARPU. However, i-channel, i-concier, map navigation part of the new business was actually redefined, and it’s going to be now included in smart ARPU. NOTTV, dmarket and mobile phone insurance, which are part of new businesses, will also be counted as smart ARPU.
These will primarily be served by smartphones based on dmarket, so we believe that this definition is probably more appropriate. Now revenue from subsidiaries, these are direct to commerce businesses involving companies, so therefore, they would also be – they would be part of others. I do not believe that revenues from subsidiaries will be appropriate to be captured by the concept of ARPU. So we have followed the trend from first quarter fiscal year 2011, and that is the trend of the smart ARPU.
We want to double the ¥400 billion – ¥400 two-fold in fiscal year 2015. So therefore, we hope that we’ll be able to further enrich more about and also we hope that this smart ARPU can be utilized to capture revenue from smartphone services. So it’s a way to capture the revenues from new businesses which are services based on smartphones.
Next, reinforcement of business structure. This is something that continuously companies must pursue. So cost reduction and also cost efficiency must be pursued. We want to cut cost by ¥20 billion by – compared against fiscal year 2011. We hope that we’ll be able to do this as soon as possible. So we will reinforce the structure based on such cost cuts and we’ll also shift managerial resources to new business areas as I mentioned earlier. For the purpose of enhancing competitiveness, we have carried out this review. So it’s a part of this overall effort.
Going on to capital expenditure, we believe that we’ll be able to peak out in fiscal year 2012. In the case of LTE, and we’ve seen growth, which far exceeds our initial outlook. So therefore, if you combine LTE and 3G, we have found that there has been much accelerated shift to LTE, meaning that costs pertaining to the maintenance of 3G services can be cut back. So therefore, we believe that we’ll be able to reduce annual CapEx to below ¥700 billion over the medium term.
Next is balancing business expansion and shareholder return. This is self-explanatory. I would be actually be somewhat reluctant to say this, but we want to realize growth and also provide shareholder return.
Now ¥6,000 is the dividend per share. Since the – however, operating income projection was down – revised downwards from ¥100 billion to ¥120 billion. However, the shareholder return and the dividend payment will remain unchanged.
Now this is a fairly new chart. Maybe it’s simply for the sake of our complacency. However, this is the way which we actually capture the – our service structure. Our service, and also network devices are indicated on the left-hand side.
Let me focus on the service component. Network devices contained in one category. The LTE Xi is the key here, reliability and speed offered by LTE. And also, we now have better ideas about the cost pertaining to repair services. So we want to further improve the reliability of Xi.
And now we come to packet revenue. In fiscal year 2015, we want to increase this from ¥1.8 trillion to ¥2.7 trillion. As far as services are concerned, we now have the cloud platform and storage. International services will be placed on top of that platform, and also we’ll be placing dmarket. So at the risk of repeating myself, this is what we need to do as a way of dmarket.
We also have the physical services. Now, the dmarket, which account for the bulk of these services, will be accounted by smart ARPU. We want to have two-fold increase in smart ARPU. So Tower Records and the physical businesses are now part of that. And eventually, this, the Tower Records and physical part hopefully could be improved to ¥50 billion.
But in any event, the dmarket part of the DOCOMO cloud universe, this is going to generate packet revenue. If you watch online video – well, if you watch five video with a high picture resolution, then that leads to a five – more than 5-gigabyte. Some people say that they want even more. So the blue is our – will exceed 7-gigabyte. It’s – the blue part, the packet revenue is very important. Since it’s important we provide greater services based on smartphones. So we’ll certainly fine-tune this and hopefully we’ll be able to show you a picture for just more straightforward.
Our next chart. So out medium targets, key indicators, we want to seek 40 million smartphone users. However, behind this picture, well, we have the 41 million target for Xi subscriber base. However, this do not – this include non-phone devices. So we just focus on 40 million smartphone users. Packet revenue, we want to increase this by 1.5 times comparing as to level of fiscal 2011. We hope that we’ll be able to have in excess of ¥1 trillion in the revenue from new business area. We have also defined smart ARPU; we want to double this. But we are so embarrassed at this moment, so we want to double this.
So I have provided to you some (inaudible) about the second quarter financial results. We will be thoroughly addressing enhancement of competition – competitiveness for this fiscal year. We want to accelerate the expansion of smartphone user base and also we want to further evolve services through DOCOMO cloud. And also by enhancing our sales activities, we want to thoroughly improve our general strength in the form of devices network and services.
For the time being, we anticipate that the competitive landscape will be very tough. However, in order to secure competitiveness in the mobile front, we will be making all our effort to pursue fundamental structural reform as well as improvement of cost efficiency. We have already launched this effort. So through such efforts, we hope to be able to realize cost efficiency in the order of ¥200 billion as soon as possible.
And also as far as operating income is concerned, we have made a downward revision as far as this full year target is concerned. But we want to once again challenge ¥100 operating income that I believe is my responsibility as soon as possible. We hope that we will be able to realize the ¥100 operating income. So that is all for presentation. Thank you very much for your attention.
Now we would like to entertain your questions. Please raise your hand and before you start with your question, please identify your name and affiliation. Now the person sitting in the front row.
Daisaku Masuno – Nomura Securities
Hi. Masuno from Nomura Securities. I have three questions. Number one, regarding the additional expenses of ¥80 billion for this fiscal year. That’s about ¥6,000 per one unit of smartphones. But this is an additional expense. So what are you going to use this for? So that’s – can you elaborate on that? That’s my first question.
And my second question is about the fact that you have mentioned you set a target to achieve ¥1 trillion of revenues from the upper layer businesses as new revenues. Of course, this is an area where you have to compete with the Internet player. So speed is of utmost importance.
For example, Yahoo! now has a new management and they are coming up with new services, one or two at least per month. So the hardest momentum that you will have to anticipate, otherwise it is very difficult for you to compete against these players. So do you think your management team is – or your management structure is enough for that? I perhaps believe that you will have to use people in their 30s or 40s as manager for this kind of business.
And the third question is that you are not going to achieve ¥900 billion operating income target. And looking at the various opinions that you have had – that you have in your company, we really, really see some delays in mail delivery because of the increase of traffic. And it seems to me that from my experience that you are not able to cope with the increase of traffic. So of course, it’s difficult to give a quantitative assessment, but independent from the nature of troubles, how are you going to cope with the traffic increase? That’s my last question.
Unidentified Company Representative
The additional ¥80 billion of expenses, so if you divide it by the number of smartphone subscribers, it’s about ¥6,000 per one unit, yes. And of course, when it comes to the competition in handsets, this is mainly going to be used for the competition of handsets, handset sales. But of course, some of the expenses will be appropriated for our promotion. And the Xi Talk 24 billing plan is not really well received or recognized by the users. So those are some others where we are going to spend this money for.
So of course so far, we have implemented various discount services such as family set discount. And from the 17th of November, we will be eliminating for some customers, such as those staying with DOCOMO for over 10-year period, to pay for such a monthly fees for up to two years. So of course, it relates to the combination of the various discount services. Some customers prefer to reduce – to minimize their monthly payment.
Some other customers want to have reduced cost burden on – upon the purchase of a new product. So it’s about how to mix these discount services. So depending on the timing when our products are renewed, for example, we will look into these matters how to appropriate these expenses in a strategic manner. So it is very difficult for me to give further comments at this point.
And regarding the smart ¥1 trillion operating income target, of course, looking into the traffic over the past, we are seeing areas where we have been strong and where we were weak. And of course, we do understand that speed is very important.
Of course, our efforts are not sufficient at all in some areas. But first of all, we would like to look into the cloud service such as the telephone, phonebook service and also the e-mail service. 70% perfection is not enough at all. Of course, even if the perfection level is not sufficient, we would like to speedily implement these services.
People in their 30s, 40s, these youngsters’ innovative idea may be necessary as you commented. That’s right, that’s correct. But it doesn’t mean that they have to be on the board or they have to be the executive directors. Like in the incubation business or we would like to look into developing these human resources and we would like to provide the chances to the youngsters. And of course, as we associate with these young leaders, I think we can expect a lot of synergies.
Regarding the traffic question, yes, certainly 75% and 90-something-percent, these are the population coverage that these players address. And of course, the ground of comparisons are quite different, so it’s quite confusing. But we have 6 million subscribers on the Xi network already and we are already comfortably handling these subscribers and I hope that you understand this.
On the other hand, we are causing some inconveniences in providing connection in some crowded space, in some crowded areas of Tokyo for example, so we are very sorry for that. But by and large, overall, in order to handle this traffic, I think traffic offloading is very important through Wi-Fi connections. And currently the dmarket video service is provided.
And for those customers subscribing to the VIDEO Store, we are providing free Wi-Fi router for those customers, which is not very well-known, but for those customers using the Wi-Fi connection at home, we’ll be able to minimize the in-home traffic around 11 o’clock in the midnight. And it is very important that we take care of this traffic concentration.
So even if LTE is quite powerful, if we have 40 million subscribers, we have to anticipate what is going to happen in the traffic area. And of course, we will make a lot of simulations and if there’s any shortage or spectrum, we will love to apply for additional spectrum to be allocated to us to the ministry. And overall by utilizing various solutions, we would like to strike a good balance.
And this is Iwasaki. I would like to add some more comments. From the users’ perspective, throughput and performance is largely determined by, number one, the wireless connections, and number two, the core network performance. These are the two factors that determine the quality. Years back, when i-mode was rapidly expanding, the server capacity was – fell short of the demand then that resulted in the delay of mail delivery.
What is happening today is not really the problem in the core network. It is more related to the shortage of wireless spectrum. So in our case, depending on some time, depending on some locations, the throughput is deteriorating. And as a result of that the delivery of mail is sometimes delayed, but the situation is quite different from the i-mode trouble of the past. And most of the problem relates to the spectrum resources in the wireless space. So we would like to replace the network to the more spectrum efficient solution like the LTE in the future.
And on top of that, we will like to take implement measures on the handset side as well. And recently, the house Wi-Fi service has a very – offers a very effective solution for offloading data traffic. So – but there are – we are – there are some locations where we are causing inconveniences to costumers and we will like to flexibly address these problems.
Tetsuro Tsusaka – Morgan Stanley
Tsusaka from Morgan Stanley. Well, you made a downward revision in your projection. To be very candid, it’s very difficult to see what you’re trying to do in general. I say this because there’s – you have taken various policies such as introduction of monthly support, you’ve expanded monthly support.
And also, when you take a look at the cellular service revenue on a year-on-year basis in the second quarter, there was a decline or reduction about ¥40 billion. So therefore, comparing that to the first quarter the decline is expanded. And also, in the case of cellular revenue, you expect a ¥20 billion decline.
I know that handset sales are very brisk, so overall revenue is on the increase on year-on-year basis. However, you’re investing a lot of capital to certain areas. But then that seems to be leading or translating into a decline in telecommunication related service revenues. So you’re putting money into areas that are losing money.
So after the first half is over, I’m sure that (inaudible) measures that you’ve adopted, (inaudible) invested capital. Maybe then – but maybe the invested capital is generating negative impact for the shareholder return, because that is how it looks because you have a decline in your revenue, in the cellular service revenue. So how do you see those?
And also what about the costs that you’re going to be injecting in the second half because on the basis on the track record so far, in areas that you’ve invested capital, you’re actually generating greater losses so how do you see about – how do you feel about that? To be very honest, I simply cannot understand what you’re doing. So this is my first question.
Now the second point, this might be a very detailed financial question, but I would like to ask. The cellular service revenue downward provision by ¥50 billion, that’s very easy to calculate and I can understand this part. However, in the case of handset sales rate, handset equipment sales, that’s increased by ¥54 billion. There’s also upward provision by ¥60 billion. So altogether, you have – you made an upward revision in the top line by ¥70 billion.
But aside from these telecommunication service revenues, equipment sales, how did this increase? Because the number of units, so can you talk about this? And also, the remaining ¥66 billion, what’s the change between the initial projection? So if you could offer me a desegregation please? A very detailed question.
My third question, in terms of your assumption, I think you were envisaging 2.01 million net adds, I believe. But then based on the run rate, it’s a matter of maybe reaching 1.55 million. So compared against the – if you add the second half of the previous year and the first half of this year, it will reach 2 million or 200,000 I should say. So I do not think you will achieve your net adds target as things stand today. So if that is the case, do we – at the end of the year you’ll also be revising downwards operating income?
You mentioned that actually investment capital has led to negative net-adds and that we are generating losses, I think that is your point. Now voice service revenue is coming down especially in the mobile area and also we are not able to offset that decline by increasing packet revenue.
So in that regard, what are we actually carrying out activities for. But, as I mentioned earlier, based on LTE and smartphones at the customer base, this LTE smartphone customer base is going to be the domain for our new business areas. So therefore, it’s important that we secure the customer base for smartphones and LTE.
And as you point out, in this case with total handset sales, as I explained earlier, we are competitive and also we are taking new acquisitions. We have inflows of customers. So it’s a matter of outflow, the port-out, that is increasing, that is the issue. So therefore, we want to be able to halt in that situation. Now, I cannot give you the details as to what we’re going to do about it. We have many ideas in mind. And day-by-day, week-by-week, we are observing this situation and we’re trying to identify what will be the best possible solution.
Now 2.8 million to 2.01 million, the net adds from 2 million down – 2.8 million down to 2.01 million, yes, that is true. It is very challenging. But then we are (inaudible) to compete and we will be introducing new ideas. So we want to respond to this situation in that matter. You talked about the ¥50 billion some ¥55 billion and ¥70 billion. I think Mr. Sato can explain about the upward revision in the revenue.
Yes. Comparing that to initial plan, in non-cellular services, we have seen increase. Yes, you point out other revenue. You saw an increase of ¥66 billion and close to ¥70 billion. That’s primarily due to the following. ¥30 billion from Tower Records and also Buongiorno, that’s overseas. The revenue that’s consolidated that has kind of impact of ¥10 billion and also we have unified billing.
So from the group companies we are generating more than ¥10 billion as a way of system processing fees. And also, there are other miscellaneous items and also equipment sales revenues. We have seen an increase of 150,000 at the wholesale basis and also the – we have seen increase of ¥7,000 at the wholesale level per handset. So as a result, we are seeing increase of ¥130 billion based on EITF. If we exclude the discount part, then this has positive impact of ¥50 billion at the end of the day.
Tetsuro Tsusaka – Morgan Stanley
Let me follow-up with a question then. When ¥130 billion cellular service revenue and reduction we’re seeing, then you talked about increase in the unit price. So the monthly support maybe could be increasing going forward. So that means that there’s a full impact of monthly support program for fiscal year 2013. So therefore, next year’s telecommunication service revenues is going to be even more – cellular service revenue is going to be even more challenging for you. That is the impression that I have. So the cellular service revenue, is there any possibility that this could reduce further in the fiscal year – in next fiscal year? Can you actually realize increase in revenue based on such an assumption? That’s my additional question.
Tsubouchi, I would like to respond. Well, it’s two – I cannot – we cannot talk about the figure for next fiscal year, but I think this relates to your first question. In other words, what about the return, what about the impact on cellular service revenue as a result of investment of our capital? Invested capital has not – had positive impact on the cellular service revenue. That’s your question, but I would like to reject that notion. It’s true that the ARPU for cellular service revenue has been going down, but despite that, we’ve able to increase and improve margin. Of course, we’ve done a lot of efforts such as cost reduction.
So therefore, we have – we now have a leaner structure. It’s not just cost. We’ve been able to increase packet revenue. And by taking overall balance we have been able to improve our profit. So therefore, over the last of couple years, we have actually improved the margin. Then why is that we cannot do this fiscal year. I suppose that is the question.
As Mr. Kato mentioned at the beginning, be it smartphones or be it network, we’re undergoing through a major transformation. This process has begun last year. So it’s important that we expand the smartphone sales as soon as possible, and also launch our efforts pertaining to the up layer services, because we will lag behind unless we do so. We have that sense of urgency.
Out of 60 million customer base, 25% are smartphone customers. We want to increase this to 34% or one-third of the total eventually by this fiscal year. And 60% to 70% of smartphone customers are on the high-speed LTE network. And also, from next year, this trend should further accelerate. If that is the case, customers who are using i-mode or 3G and FOMA, these services which were not possible is going to be possible under smartphones and LTEs. And that is going to translate into our future revenue. So even at the cost of spending money at this moment, we want to spread the penetration of smartphone as soon as possible so that we create the cloud platform. This I believe is the major point of change for us.
So on a short term basis, yes, our profits may decline. However, this is another cost investment to pave the way for the future. That is the decision that we have made. I would appreciate your understanding on this.
Next question, please.
Hiroshi Yamashina – BNP Paribas
BNP Paribas. My name is Yamashina. Thank you very much for your explanation. I would like to have three questions. First, in the presentation on page 34, you are talking about the new business revenues. Based on the track record of first half, what’s the PL right now? And when you develop these numbers, when you actually achieve these numbers, how much improvement of profitability can you expect as far as you can comment at this point? That’s my first question.
And second question, in relation to the first question, you are going to establish a new innovation fund. Now reporting lines, who is this organization going to report to? Is this different from the DOCOMO.com approach? Are you going to establish a new innovation fund on top of DOCOMO.com or is this something totally separate? With respect to the details, I think the – what you’ve actually done under this fund may seem to be very quite similar to what has been done under DOCOMO.com, so can you elaborate on that?
And the third question is another related question. Regarding your handset sales policy, regarding how you spend expenses and how you conduct marketing. For example, iPad Mini is now becoming available and if you compare that with Kindle, 7-inch devices is becoming the mainstream. And if you compare against NO8-D, you have a very light compact device, but it’s not taken up by media. When you have this good product, it’s not taken up by the media at all, how do you perceive this situation?
So even if you spend a lot of money for promotion, it’s not going to lead to any subscriptions. And if that’s the case, something is fundamentally wrong. So can you comment on that one? That’s my third question. Then the last question, you said that there’s something wrong.
Well, Kindle Fire, Nexus 7, iPad Mini. These devices are becoming available now and surplus as well. So the 7-inch size tablets drawing a lot of attention in the market. That’s true. And we are aware of that. And of course, many articles compare these products and this is going – is said to be the main battlefield of the tablet devices. And 249-gram Medias product is not really taken up by the media. Maybe we were too early in introducing this product and also the Wi-Fi-enabled models.
We’re not really drawing a lot of attention maybe. Not maybe the cause of the problem, but we would like to make efforts. Going forward, when the 7-inch tablet – I’m not really sure if this is going to be the main battlefield. We would like to observe the situation to make a judgment. We do have a 7-inch product as well. So we would like to take part in this competition.
So, of course, there are some note-sized devices, smartphone devices as well, and Mr. Jobs as far as what I hear, he said that he is still alive according to what people say. So I’m not really sure which will be the most critical price point for a customer. So we will like to closely monitor the situation.
And the second question regarding our venture fund, actually the size of the fund is quite different from dotcom, and also the case of dotcom they are doing a certain degree of venture fund. This is more or less for the venture fund, not really the incubation project. So we will like to incorporate this venture fund in a very different vehicle this time around.
And all three of us will commit ourselves in overseeing this new venture fund. Not only Japan, but overseas ventures will also be centrally controlled under this umbrella and we will like to oversee this at the corporate level. So in order to prevent any situation where the operational level is not really aware of that. So we don’t want to restrict the activities on the other hand. So a dynamic use of this fund is something that we will like to achieve.
And regarding smart ARPU, I think you are talking about the breakeven point of smart ARPU. We don’t have the exact numbers here, so I’m not very – I’m not really possible to answer to that question. But, for example, when it comes to the VIDEO Store, we now – the subscriber base, this is going to be 4 million by the end of the fiscal year with ¥25 billion of revenues. But when we have 3.5 million to 4 million subscribers including the cost per servers. I think we will be able to achieve breakeven. On the other hand, the smart ARPU is going to be ¥500 billion or ¥520 billion in the future in terms of total revenues. But when it comes to profit margin, I think it’s going to be somewhere around 10%, 5% or something because most of them are digital content.
When it comes to the physical merchandise business, as we have been stating from before, the operating profit margins is like 3%, 5% only, but still this is going to generate additional packets. So in light of that, we would like to make smartphones an effective tool for realizing smart life on the part of consumers. So we hope to serve these everyday needs of customers with our smartphones because smartphones after all is just about – is just a supercomputer in your palm. You can do virtually anything with that.
And there are many customers who would like to seek recommendation from NTT DOCOMO. And that is why we are going to recommend video service, for example, and this is receiving a lot of great reviews from many customers. And that’s the reason why the subscriber base has expanded to nearly 4 million now.
This is Tsubouchi. I would like to add some comments. I’m not sure if this is going to be of any reference to you. But anyway, the profitability of digital content business is a question I think. But based on our experience, we have a huge experience with traditional i-mode business. And as for the fiscal 2011 results are concerned, excluding traffic contribution, the bill collection revenue which is only a 9% commission level. But in – as a result of the fiscal 2011, we’ve achieved ¥27 billion of revenues on the bill collection service only.
So if you reverse calculate that, you’ll be able to understand that ¥300 billion of revenues were generated on i-mode business, out of which we’ve received 9% commission which totaled ¥27 billion. So on top of that, based on that, we will transplant this i-mode experience on to the smartphone business plasma model. And I think that will be – absolute size of the business can be expanded with smartphones. And also, we can seek additional revenues from physical merchandise business. That’s the point.
So then there are many digital applications and the – like Google and Apple, their profit distribution is 30% versus 70% into the content holders. So our commission fees can also be expanded, maybe not as much, but definitely it’s on a higher degree than what we have today. So – but the profit margin for the fiscal business is only single digit. So that’s the overall picture.
So out of the total ¥500 billion revenue size, Radishbo-ya, Tower Records and so forth, these companies will be responsible for generating profits at their own level. And many of them are generating double-digit profits or breaking even already. So altogether, we will like to achieve ¥1 trillion of news revenues with 5% to 10% profit margin level. So it’s all about how much synergy we can develop out of this service.
And if I can also add some other comment, that’s about the profit loss observation. But i-mode is just about a market providing the platform and venue for the business. And it’s just about a small commission fee that we have been receiving for the distribution of the digital content. But in the case of digital – dmarket concept, DOCOMO is a service directly operating the market itself. So the DOCOMO can incorporate the entire revenue as our own revenues. And there are – this business is going to be sustained by many players on the background and therefore the profit distribution is quite different, much larger than the 9% level that we have been commenting from before.
So altogether, in that environment, we would like to achieve profit margin of something greater than 10%. So I just wanted to comment that the profit level that we can seek is somewhat higher compared to the traditional i-mode business.
I’m afraid we are fast running out of time. So we’ll take final two questions.
Hitoshi Hayakawa – Credit Suisse
Hayakawa from Credit Suisse. For those of us who are here in this room have covered the stock market for the last 10 years, maybe even more, at least I have been working with DOCOMO for the past dozen of years. But I have never seen this level of insincere presentation, today’s presentation – the substance of today’s presentation.
First, you should talk about why it is that there is ¥80 billion downward revision in your operating income and also the fact that the packet revenues are stagnant and the total service revenues are coming down. You should have provided a structural presentation. You should talk about how spending ¥80 billion is going to help that situation. You should spend bulk of the time for that purpose.
And as you talked about ¥1 trillion from new business that’s your management policy. It’s an excellent policy. But you have mentioned the market, the margin whatsoever. And also, you have to generate a compounded annual growth rate – a very large growth rate if you are to reach ¥1 trillion. If you do not reach that, who’s going to take responsibility? What about the margin for AP settlements. It’s very dangerous. Are you going to buy anything just simply for the purpose of attaining ¥1 trillion from new business?
So you talked about Buongiorno, Radishbo-ya, they’re high margin, you talked about that. But cash flow, your cash flow is declining. So it’s not translating into revenue. Free cash flow is declining because of the downward revision. Net income might be increasing but free cash flow is declining on your part. In other words, the business that you’re carrying out is simply burning cash. Is that going to lead to increasing cash flow?
We do know – we do not have any idea. You’re talking about the – there was more than ¥100 billion, that’s ¥1 billion increase in CapEx. You talked about declining it. But we have no idea what’s going to happen. So that is why your stock price is as it is. So your understanding of the situation is simply very weak. It’s not about iPhone. Why is that you’re losing customers? Why are you in this particular situation? Why is it that your packet revenue is not increasing? You should have delved further.
And also, you should talk about the return based on injection of ¥80 billion, maybe (inaudible) but 99% of the people here say that this ¥80 billion is going to simply be channeled as marketing expense. So this is going to be not spent, not for the investors but for the consumers. So your stock price is not going to increase.
We are sell side analysts and we prepared a model, a projection. And we will provide very serious decision basically the buy side analysts. The buy side analyst, they are fiduciaries of the investors. This ¥80 billion downward provision, the decline in free cash flow. How should we address and treat your stock? We are very, very perplexed. Is that so much a response that I want? Please hear this as a cry from my soul, cry from the heart. A stock with this level of market cap is – has a very lackluster share price. You’re losing customers to others. How does the management team understand this situation?
That’s a very critical issue here. Based on the presentation here, the message is that we’re spending ¥80 billion. Now we’re going to generate ¥1 trillion from new business and that’s it. That is all the message you’re communicating to us. You should have provided much more information about the return. So can you share with me the thinking on the part the management team right now on this particular issue?
Unidentified Company Representative
Well, you pointed out that it’s not very kind presentation, you also mentioned that this is a cry from your heart. I will very earnestly and seriously take your comments, at the risk of repeating myself.
Packet ARPU is declining vis-à-vis with other competitors. Yes. I take note of that. But I’d like to say that we’re enjoying growth there. So that’s why based on LTE and smartphone customers, we want to be able to secure sufficient customer base to capture that packet revenue. Yes. We’re in a very difficult place right now. But we’ve – the ¥80 billion addition is actually illustration of our intention to compete.
Now numerically speaking, what return will be generated. Yes. I take your point. But under this environment, this is very difficult for me to say and pinpoint a particular number. We do have some ideas internally but as much as possible we want to expand the customer base.
Now one aspect of this issue is that the overall net adds are not very large in size. However, we’re still competing over that particular market share and some risk might be involved in that type of competition. But we have to naturally counteract our competitors and we have to take certain actions, please understand that.
Final question please?
Yoshiyuki Kinoshita – Merrill Lynch
My name is Kinoshita from Merrill Lynch, I have two questions. First, this fiscal year you are going to compete against the competition in order to prepare for the future but when you get a subscriber content, it seems that the decline has not halted yet. It’s not – it hasn’t bottomed out yet. So if things turn out not as you planned in the second half, are you going to attach priority on profitability or acquisition of subscribers? Which is your highest priority? That’s my first question.
The second question is about, maybe related to the previous note, that on this churn rate declines, it is impossible for you to achieve these numbers. But on the other hand, in reality, the churn rate has been climbing. So what’s the reason behind the increase of churns and how are you able to reduce the churns?
Maybe the competitors will keep spending money. This might be your excuse but these players will continue spending money, I think. It won’t change. It won’t change significantly going forward, so then how are you going to improve your churn rate performance in your view?
Unidentified Company Representative
That’s something that I’m not really sure of because maybe you might be able to increase your gross adds by spending money, hefty money, but you won’t be able to improve the net adds.
It is correct. That’s a very big point. What do we have to do in order to halt the decline is something that we’ve been thinking about. But it is impossible for us to disclose that because this will divulge a secret of our compete – of how we try to compete in the market.
Now, whether we attach priority on subscribers or profitability. Actually, we thought about this a lot. And before making this decision of this downward revision, we thought that we have to secure a certain number of subscribers. And for that reason, we have decided to add our expenses by another ¥80 billion or so. So please take that as our intention.
Yoshiyuki Kinoshita – Merrill Lynch
Then a follow-up question. In the third quarter, if there’s any change, for example, if your strategy doesn’t work out then are you going to change the profit target rather than the number of subscribers?
Well, this is our view at this point. Day by day, week by week, situation change, so we will monitor the progress.
Yoshiyuki Kinoshita – Merrill Lynch
The third question, so you said that you cannot comment on the detailed strategies as to how the turnaround of the churn rate. Then when are we able to hear the concrete measures that you’re contemplating.
Unidentified Company Representative
Well, from time to time, handsets billing plans, we will look into them and we will consider what is the most effective measure, and they will be announced from time to time.
I’m Tsubouchi, I would like to add another comment. As the CFO, I would like to make although this maybe a general comment but DOCOMO still have a room for cost reduction as a company. So we talked about ¥200 billion for the next few years but we still have ¥10 billion for additional cost reduction. And we’ve already done ¥150 billion so far. So we will like to seek further cost reduction going forward. And for cash flow generation over the medium-term we are very confident this fiscal year, although we are expecting a slight decline as we have explained because of the increase of usage – using installment payment.
This means that we will continue to have an increase of subscribers who will continue to pay to DOCOMO. So this is a temporary increase of cash outlays. But we are capable, in my view, of generating that cash for – in the order of ¥400 billion per annum. So that is the reason why we decided not to change the dividend payment as planned. I hope to seek your understanding. Thank you.
I do understand that we still have – see some hands. But we’ll try to prepare some different opportunities for – to continue with your questions.
With this, we would like to finish this session at this point. Thank you very much for your attendance despite your busy schedule.