KT Corporation (KT) Q3 2016 Earnings Report, Transcript and Summary

[interpreted] Good morning and good evening. First of all thank you all for joining this conference call. And now we will begin the conference of the 2016 third-quarter preliminary earnings results by KT. We would like to have welcoming remarks from Mr. Youngwoo Kim, KT IRO, and then Mr. Gwang-Seok Shin, CFO, will present earnings results and entertain your questions. [Operator Instructions] Now we would like to turn the conference over to Mr. Youngwoo Kim, KT IRO.

[interpreted] Good afternoon, I am Youngwoo Kim, KT's IRO. Let us begin our Q3 2016 earnings conference call. Our call is being webcasted via the Company's website and please refer to the presentation slides as we present the business results. Please note that since Q1 of 2011 KT has been presenting consolidated numbers under the IFRS accounting standards. Now, our CFO, Gwang-Seok Shin, will deliver his remarks on Q3 2016 results.

[interpreted] Good afternoon, I am Gwang-Seok Shin, KT's CFO. In Q3 based on differentiated offerings of GiGA infrastructure service, such as the GiGA Internet, GiGA WiFi, GiGA LTE our top-line growth of core businesses fixed and wireless continued. Also with improved profit generation from our subsidiaries, making contributions to our earnings, KT achieved KRW400 billion level operating profit consecutively for two quarters in a row. For the fixed and wireless business we separated enterprise and subscriber networks, designing a specialized private LTE that ensures both security for corporate and personal information protection. Also KT-only device and second device, which are most optimized for consumer needs, supported subscriber acquisition thereby bringing M&O net additions to its highest level since 2012 to 180,000 net adds per quarter. On top of that for the fixed line business GiGA Internet achieved yearly target of 2 million subscribers ahead of plan in Q3 underpinned by broader GiGA coverage and bolstered foundation for the services. For the IPTV the launch of Olleh TV Air Korea's first wireless environment for viewing and other innovation efforts help to continue the net addition trends by gaining 120,000 subscribers in Q3. KT's strategy is to drive sustained growth for fixed and wireless business through a sophisticated GiGA network and GiGA product offering. Based on ever more upgraded service and coverage we will usher in the age of GiGA 2.0, where people can experience speed above 1 gigabit p/s regardless of fixed or wireless so as to change the competitive paradigm of the conventional telco market. In terms of the future business we are starting to see visible results from energy and security, which are the core business areas. For the platform business we are tapping into new markets as we continue to introduce new O2O and content platforms. As we commercialized LTE M nationwide network for the first time in the world, favorable business environment was laid out allowing for various different product launches bringing vitality to our business. According to IoT statistics of MSIP since the first quarter IoT market share has been increasing gradually. KT will lead the response to new market changes as well as enhance overall business efficiencies by way of affecting structural cost efficiencies with a view to continuing stable profit realization. With that let me move on to Q3 2016 financial results. Q3 operating revenue was up 0.7% year over year to KRW5,529.9 billion on growth in service revenue despite significant declines in merchandize revenue due to seasonal factors such as summer vacation, holidays and suspension of Galaxy Note 7 sales. Operating profit was up 17% year on year to KRW401.6 billion. With KRW234.5 billion of net income and KRW1,236.3 billion of EBITDA. Next is operating expense. Q3 operating expense came in at KRW5,128.4 billion, declining 0.4% year on year. Marketing expense was down 3.6% year over year on early attainment of GiGA subscriber target. Next, is our financial position. Q3 debt to equity ratio was 137.9% down 16.5 percentage points year over year. Net debt ratio was 37.7% down 9 percentage points year on year. Next is on CapEx. Total CapEx spent up to Q3 amounted to KRW1,233.9 billion. We started investments on new spectrum since last July but with continuous cost saving efforts and better efficiencies in spending we plan to spend within the annual guidance of KRW2.5 trillion. Next, is on the performance highlight for each of our business lines. Wireless revenue was up 2.2% year on year to KRW1,884.1 billion. Although Q3 LTE subscriber share expanded to 74.5% of the total base, wireless ARPU fell 0.6% Q on Q to KRW36,298 due to changes in accounting treatment for handset insurance sales and growth in second device subscribers. Next, is on the fixed line business. Fixed line revenue fell 2.3% year on year on PSTN revenue erosion. But we were able to acquire 2 million GiGA Internet subscribers early on and with more customers using premium product that offer a faster speed, broadband Internet revenue recorded a growth of 11.4% year on year, continuing to grow five consecutive quarters. Next, is the media business, media and content business. Media and content revenue was up 15.3% year over year to KRW494.6 billion, hitting new records every quarter. KT, with its biggest IPTV subscriber base in Korea was able to bolster its profitability through high quality subscribers and expanded top line by utilizing platforms such as advertisement and also launched Olleh TV Air offering wireless-based IPTV environment for the first time in Korea as part of its unwavering efforts to lead innovation. Next, is on financial and other services. Financial revenue was up 3.7% year over year to KRW866.4 billion driven by solid CC Card revenue on the back of higher credit card usage as we see more small ticket transactions. Other service revenue was up 7.3% year over year to KRW539.8 billion driven by revenue growth of real estate and other subsidiaries.

[interpreted] For more details please refer to the material that's been circulated. We will now entertain your questions.

[interpreted] Now Q&A session will begin. [Operator Instructions]. Our first question comes from the line of Hoe Jae Kim of Daishin Securities.

[interpreted] I would like to pose two questions. The first has to do with your wireless ARPU. Starting from month of September, there has been some change in the way you calculate for wireless ARPU, basically the handset insurance has been excluded. And if you look at the Q3 figure, there has been a Q-on-Q decline. But if you were to make the calculation as you did in the past based on the same formula. If you can't share with us the exact ARPU figure, can you at least provide some color as to whether it will be a higher figure or a lower figure? Second question has to do with the GiGA Internet. You mentioned that you achieved the GiGA Internet subscriber target early on. Can you share with us as to what then your subscriber target will be for the end of this year and for 2017? And I think we have now full-fledgedly gone into the age of GiGA Internet. When broadband was first introduced I think basically people assessed based on the amount of usage per these different lines. I think it was called the dumb pipe as well. Can you provide us whether back in the -- in the age of GiGA Internet we will be able to see or base assessments other than on the usage of the lines?

[interpreted] Responding to your first question about the handset insurance, basically we have excluded both the revenue and expenses related to handset insurance. So basically there is no impact on the P&L. However, there will be some declines on the related top-line revenue figure. So the amount that had been excluded for the month of September amounts to about KRW12 billion. If you were to take that impact out then on a Q-o-Q basis there would have been 0.2% increase. There has been some impact on the ARPU figure because of the different accounting treatment for the handset insurance. But if you were to take that impact out we believe that due to the continuous increase in the data usage the mid to long-term ARPU trend upward still stands and is still valid. And also we see subscribers who have taken out non-unlimited plans are increasing their data usage as well. And we see that more than 50% of LTE subscribers have taken data select rate plan and hence we expect from a mid- to long-term perspective a positive ARPU trend driven by data will continue. Responding to your second question, as we see more subscribers of GiGA Internet we are seeing improvement in broadband ARPU but at the same time the bundled product is becoming a very important marketing tool and it is having a positive leveraging effect on other types of businesses as well. In terms of the ARPU compared to the existing Mega Internet product the ARPU is about 25% to 50% more higher. And as we see more subscribers to the GiGA Internet, very naturally, our average quarterly ARPU is at around 0.5%, so we see 0.5% broadband ARPU growth. And in terms of the GiGA Internet, compared to the Mega Internet, the bundling rate with adjacent services are about 20% higher. And also therefore it is making a very positive contribution in acquiring the relevant business service subscribers as well as their retention. And we believe that when other future generation telecommunication and media services such as UHD really becomes more vitalized that GiGA Internet would become a core infrastructure for making contributions to a growth in the converged services of not only telecommunications but also media. You also asked about the subscriber target. We were able to achieve this target early on at 2 million and we think that by the end of the year this subscriber number will stand around 2.3 million. In terms of the net addition speed after this year we think that the speed will start to gradually slow from a mid- to long-term perspective as there is going to be more heightened need for faster speed at GiGA level and expanded offerings of differentiated services. We believe that the demand for GiGA is gradually and continuously going to go up. And we, as a Company, will flexibly respond with appropriate subscriber and marketing approaches.

[interpreted] Our next question comes from Jong-in Yang of Korea Investment & Securities.

[interpreted] I have two questions. The first, in year 2016 we saw improvement into a profitability, which has been mainly driven by regaining of competitiveness in your core businesses and also saving of costs including marketing. I would like to understand what you think is going to be the driver behind profitability improvement in year 2007 and onwards, will this be mostly driven by your real estate business or IPTV business, could you provide some color, because in the market there is a concern that from next year there will be sunset provisions on the handset subsidy and that could actually once again reignite competition in the market, and hence I would like to understand what you think the profitability trend is going to be going forward? Second, I would like to understand what, on a cumulative basis, your LTE subscribers who have taken out unlimited rate plans, what is the portion of these people and of the new subscribers coming in how many people are actually taking out the unlimited rate plans? With the increase in people using the unlimited plan and with the increase in the data use and the traffic I would like to understand what the next year's ARPU trend is going to be like?

Responding to your question about 2017 outlook, since we, at this point have not yet finalized our 2017 business plan I believe it is a bit too early for us to paint the specifics. However in 2016 we were able to bring improvements mostly driven by our core telco business, some qualitative improvements there as well as with cost savings. And we think that these trends will continue on into 2017 as well. And on top of that, with the new growth businesses to which we have been laying the foundation, as we are able to see some sizable results from these new initiatives we believe that also in 2017 we will be able to sustain a quite stable bottom line trend. Of course, the PSTN revenue decline and erosion will continue, but with the lowering of the revenues, the overall burden on the profit is also declining at the same time. Already this year if you see our broadband Internet and IPTV, they have started to make up for the erosions on PSTN. And in 2017, we expect IPTV to make bottom-line contributions and also we expect for the real estate business we will be seeing some generation of revenues under full swing as according to the mid- to long-term development plan. And with such developments I believe that we will be able to sufficiently offset the declines being created by the PSTN erosions. And for the expenses, if you look at the key expense items such as marketing expense and depreciation, we are seeing downward stabilization and also together with making our processes more efficient and improving our workflow we will continue to bring about structural efficiency in the cost. In terms of the competitive landscape, even if the subsidy limit is lifted, we believe that a transparent distribution structure -- in light of the transparent distribution structure that had taken root as well as the saturation in the market and a similar level of competitiveness across three telcos, the three operators, we think that for reckless -- we do not believe that reckless subsidy based competition is realistic. But at KT we believe that securing growth engine is greatly important and we believe differentiated network and through the differentiated service offerings that we provide we believe that we must be able to keep to the current level of market share. Responding to your second question about the subscribers who are using the unlimited rate plans, right after the introduction of the handset subsidy and it did decline to early 10% level but with greater benefits and also more greater needs of the subscribers as well as benefits such as the VIP pack we were able to recover 30% to 40% as compared to before the handset subsidy act. And from a cumulative subscribers basis, as we see the presence of such subscribers increasing and also more solidified retention we are seeing continuous increase.

[interpreted] Our next question comes from the line of Sung-un Young, JP Morgan.

[interpreted] So I have couple of questions. The first, so in terms of IPTV earnings for 2017, what is the expectation that we can actually have? Can you provide some color there? And I don't know if it's possible under the Korean situation, but do you think that achieving economy of scale through merging with cable TV operators, is that a feasible option in Korea? Can you, and if that is such case, will KT entertain such possibility? And also in 2017, we expect spectrum related expenses or cost will start to rise and hence there will be a ceiling on your operating profit growth potential. So in terms of therefore cost cutting where can we expect additional cost cuttings other than CapEx, labor, et cetera?

[interpreted] Before I respond to the question that was just raised, I just wanted to also say a couple of things about the mid- to long-term ARPU trend, which was asked previously. Because of the adjustment or the accounting treatment difference on the handset insurance, I mentioned that that had an impact on our ARPU, but even excluding that we believe that with the increase in the data usage we will be able to expect mid- to long-term ARPU growth trend going forward. Other than the insurance accounting treatment in 2016, we've also seen some growth in the IoT second device adoption rate and that will also impact the ARPU. So, we are very closely monitoring the overall trend. [interpreted] Now, coming back to your question on IPTV profitability, KT has designated 2016 as a year of a turnaround and our objective is to become an unrivaled number one player in the IPTV segment. Now, in terms of subscriber acquisition and sourcing of content as well as sale of bundled products, we do expect more heightened competition but underpinned by our competitive service competitiveness we wish to improve the quality of our subscribers by acquiring high ARPU subscribers, and also through cost innovation such as reducing and cutting the CP fees and commissions, we wish to continue to grow in terms of quality. So based on increases in the revenue per subscriber, and by achieving cost efficiency we believe that we will be able to hit breakeven point by the fourth quarter of 2016, and we'll start to see a contribution to bottom line on an annual basis starting 2017. We will continue to work on improving profitability so that within a year or two we will be able to achieve a profitability level that is commensurate to other telecom businesses. Now with regards to the recent discussions on the enactment of an Integrated Broadcasting Business Act we believe that from a big picture perspective, it will be positive in the sense that overall PTV related regulation will be more uniform and more transparent. Having said that the details have not yet been set, it will be set in detail through enforcement decree, so it is a bit too early for us to say whether this will be of an advantage or a disadvantage. And currently, the pay TV related development plans are being discussed by the taskforce teams and the most recent drafts have been disclosed and we believe that going forward there will be public hearings and different discussions through which process this will start to be finalized. So since that is the backdrop based on which we are currently operating in, it will be difficult for us to voice any position with respect to potential cable TV -- M&As with the cable TV operators or synergies. So, at KT we will continue to identify opportunities, where we could structurally cut costs. Once again, we are currently working on next year's business plan, so it will be difficult for us to provide you with the specific figures or numbers, but we believe that with continuous endeavors in bringing about structural cost savings, and once those efforts really do bear results, we think that that will have an improving impact on the earnings of KT.

[interpreted] Our next question come from the line of Sam Min of Morgan Stanley.

Thank you for this opportunity to ask questions. My first question is on CEO Hwang's current tenure. I believe his term ends this year, and I was wondering if he can provide some details of his reinstatement for the second term? And my second question is, again another sensitive question but it's on early retirement program. KT has been implementing ERP, every five years since 2003 and the next one should come in the year 2019. Given the improvement in operating profitability of late, do you think ERP could still be considered to unlock value for shareholders, going forward?

[interpreted] The first question you asked about the second term of our current Chairman Hwang, to share with you the typical process, we will have a Nomination Committee, who will make nominations by the end of this year or early next year. But as far as I know, at this point, nothing had yet progressed, so please do understand that we won't be able to share with you, anymore any specifics. Responding to your second question from 2014 the Company has been endeavoring in order to achieve turnaround in its telco business and also to bring about cost efficiencies and one way to attain that had been a significant restructuring in its headcount structure. We are aware that compared to our peers in the industry our headcount is larger but at this point we do not have a plan to significantly restructure our organization. We believe that rather than arbitrary restructuring of the human resources we believe that we want to focus more on improving productivities of our existing resources. Now having said that, with the adoption of the peak wage system we believe that this could start to alleviate the burden on the labor cost and by 2020 we will see natural retirement take place. So from a mid- to long-term perspective we could expect a virtuous cycle of human resources management.

[interpreted] Our next question comes Dan Kong of Deutsche Bank.

[interpreted] I have one simple question. Usually in the fourth quarter there's been quite a big of a seasonality for you on your expense items. With your structural cost cutting efforts, for this fourth quarter can we expect elimination of that significant seasonality impact? If that is the case, last year there was a quite significant seasonality impact, what is different about this year?

[interpreted] For the past number of years in the Q4 there were seasonality and one off factors and we had endeavored quite a bit to get rid off or mitigate the impact and we expect that we would be able to see good outcome starting this year. Having said that in light of the characteristics of the payment of the expenses and the settlement of the expenses it will not be possible to 100% flatten the seasonality impact. In terms of the sales there was this negative impact from Galaxy Note 7 recall and the suspension of sales waged on the wireless distribution and sales market. So, we would have to wait and see what impact the new iPhone model will have and how much it will help to vitalize the market again. That's one of the key factors we need to watch out for in the fourth quarter. On the affiliate side, in light of the Q3 accumulated -- Q3 earnings on a cumulative basis and in light of the annual guidance we believe that Q4 will -- is expected to record a lower level of profitability as compared to the previous quarters. Having said that already by the third quarter on a cumulative basis, we were able to achieve KRW1.2 trillion of operating profit, similar to the level of last year's annual earnings figure. For the remaining time we will do our best so that we may meet the expectations of the market.

[interpreted] With no more questions we would like to close our Q&A session.

[interpreted] Thank you very much for your interest and your questions. This will bring us to the end of our earnings presentation for third quarter 2016. Thank you.