KT Corp (KT) 2005 Q2 法說會逐字稿

Good morning and good evening. Thank you all for joining KT's conference call. And now we will begin the conference call 2005 second quarter preliminary earnings results of KT. This conference call will start with the CFO's opening remarks followed by a Q&A session. English translation will be provided for your convenience. [OPERATOR INSTRUCTIONS]. We would like to commence our opening remarks by KT's Mr Haing-Min Kwon.

Good afternoon I am Haing Min Kwon the CFO of KT. Thank you for attending KT's 2005 second quarter earnings conference.

In the second quarter KT has been surrounded with difficult situations from both inside and outside. In terms of regulation Korea Fair Trade Commission has levied 116 billion won in penalty and KT was selected broadband dominant operator and there was a policy announcement on VOIP.

In terms of sales, fierce competition amongst the operators in the broadband market made our sales activities quite difficult. However despite tougher regulation and competition KT's strengthened brand loyalty, service differentiation as well as acquisition and retention of subscribers. As a result broadband subscriber net adds was 39,000 recording 6,172,000 total subscribers. For PCS resale, net addition was 53,000 totaling 2,530,000 subscribers.

The [ILD] service which combines the convenience of mobile phones to a fixed line service recorded a net addition of 390,000 just this quarter totaling a subscriber base of 780,000 showing that KT has continued to expand its stable subscriber base as the market leader. However, the total revenue is 2,990.7 billion won which is a decrease of 41.7 billion won on a year on year basis due to the reduction in PCS handset sales.

Marketing spend has increased due to our efforts to expand and retain subscribers. Also Korea Fair Trade Commission's levy and [raise] increase for 2005 was reflecting decreasing the operating income by 238.8 billion won compared to the same period last year, and recording 339.1 billion won. Despite the fall in the operating income there was performance improvement in the subsidiary company and gain on the disposition of investment assets, ie Inmarsat. Also with the reduction in the non-operating expense, net income increased 29.5 billion won to record a sound 243.2 billion won.

Considering the performance up to the first half of the year, although it is challenging, I believe annual sales guidance of 11.9 billion won is achievable but we will be changing the operating income target from 2.1 trillion to 1.8 trillion won because of the Korea Fair Trade Commission's levy, rate increases and the competitive landscape.

When operators compete in a saturated market, competition of attrition inevitably repeats itself leading to increases in marketing spending but with sales stagnant, we cannot allow a constant increase of market expenditure. Therefore as the CFO, I will make sure that by driving efficient spending through cost of performance analysis, marketing efficiency validation that marketing spending is clearly cut from the third quarter. I will lead so that our business is centered more on ARPU improvements rather than subscriber increase. But a more fundamental solution will be to carry forward the [inaudible] and IPTV initiatives as well as other growth engines, and to sort out numerous related regulations so that the telecom market's total pie can grow. KT as a market leader will continue to do its best to open up a new telecom market.

With that I would now like to take questions.

Now the Q&A session will begin. [OPERATOR INSTRUCTIONS]. The first question comes from [inaudible] from [Hambro Securities].

It seems like the labor expenses for the second quarter has increased so I would like to ask you to provide us with a guidance for the labor costs for the second half of the year as well as next year.

And since Korea Fair Trade Commission has levied the penalty in the amount of 116 billion won we haven't heard any news after that event so could you give us an update as to how things are progressing?

And also when do you perceive the deliberations on the long distance international call and broadband will take place?

And with respect to that, 1.8 trillion operating income guidance, has that number reflected the penalties that were levied with respect to the long distance, international and broadband services?

First of all with respect to your question on the labor costs, KT has conducted a negotiation between the labor and the management and we have reached a tentative agreement. And that very outcome is reflected in the first half numbers and we believe that in the second half not the same level of impact will be seen with respect to the labor expense line item. So compared to last year there is about a 280 billion won increase in terms of labor costs. And if you look at each factors with respect to the basic salary paid there was 3% increase and KT up to this point compared to other companies have had a very low wage increase rate and the labor has strongly made this fact known and have demanded certain compensation. So we have decided to provide a special performance pay which is a one-time pay.

And there is also a natural increase in the job levels and we are recruiting experienced workers into the company which is bringing about an increase in the total workforce. So all of this is impacting the increase in the labor costs, so compared to last year yes there is a slight increase.

With respect to next year's labor cost, because we still have to go through labor management negotiations for that number it's very hard to say at this point. However if you look at this year's total labor cost it's 2.6 trillion won and that includes one-off special performance bonus payments so we believe that next year we will see a lower labor expense, lower than 2.6 trillion won.

With respect to the progress after the levy of the penalty by KFTC, at this point KFTC has not yet officially requested -- officially given us an official document on the payment of the penalties as of yet but once that official document is received we will make the payment and then go ahead with the legal procedures.

With respect to the deliberations on the long distance, international and broadband services, we believe that deliberation will take place either end of August or somewhere around beginning of September.

Your question on operating income, 1.8 trillion won yes it does reflect the additional penalties and we did book it, however that's a very tentative number and it will be improper for us to disclose that right now because that number may impact the deliberation process from KFTC.

The next question comes from [inaudible] of Nomura Securities.

Good afternoon, thank you for the call. I just have two questions. With respect to the labor expense if we assume next year labor expense comes in slightly below 2.6 trillion, say 2.5, that still likely means that relative to sales it will exceed 20%. So is the company doing away with its target of trying to keep labor expense within the 20% level of sales?

And then secondly the others, line item in operating expense, if we exclude the KFTC related penalty, I think it comes out to about 198 billion, that's still a 60% increase year by year. So can you explain the large increase in this item? And can you just explain what this line item consists of? Thank you.

We will continue to pursue and try to contain labor costs within -- below 20% of the sales but temporarily we do admit that we were lagging behind in really adjusting this increase in the labor costs but that is mainly attributable to the fact that we were not able to incur sales to a certain level that we had expected. But our long term objective once again clearly is the fact that we will contain labor costs below 20% of the sales.

You pointed out that even excluding the penalty, still the operating expenses have increased significantly. That is because in the second quarter our competitors have undertaken very aggressive sales activities and the competition deepened, therefore we were in a position where we had to spend promotion costs and spend more commission. Therefore from third quarter as I have mentioned previously we are going to be managing these line items more stringently so that from third quarter we will no longer see a significant increase in the operating costs, from third quarter.

Okay I'm sorry I understand the part about marketing expense, but maybe the IR team can send us a breakdown of the others line items within operating expense because that seems to be up significantly relative to the previous year, even when excluding the FTC related fines.

Yes we will do that.

Okay thank you very much.

There are currently five people waiting with a question. The next question comes from [inaudible].

Thank you very much for the call. My question is just on your defective tax rate. In the second quarter it was about the same as the first quarter but from what I understand the fines levied on you are not tax deductible, so a tax charge in the second quarter is a little lower than I would have expected. From what I understand you got some tax breaks on CapEx for new technology equipment. Could you go into a bit more detail on those tax breaks and also what your overall CapEx plans are for the year? I think you've spent just over 800 million won so far CapEx in the first half. Whether you're still keeping to the previous guidance of 1 trillion won, or whether that's going to come down as well. And of that, how much do you think you will get a tax break from? Thank you.

Let me maintain the annual guidance of 2.2 trillion won and when we make investment on assets relating to the business, we roughly get about 10% tax deduction so I think that will be around 10% tax savings.

And we project the effective tax rate for this year will be below 30%.

Okay thank you.

The next question comes from [inaudible] of UBS.

The first question relates to PowerCom, I guess now it's pretty much final that they are coming into the market. If you could actually comment about the expected impact and some of the potential restrictions that may be put on PowerCom once they've entered the market?

Secondly you mentioned a high degree of confidence in lowering your marketing expense in the second half. To be fair historically that [inaudible] has not been evident, and secondly you have new pressure with the PowerCom entry so I just wanted -- how do you have so much certainty that you will actually implement the -- be able to lower your marketing costs?

And thirdly any update on what you expect in terms of the handset subsidy? I guess in the next one or two months the regulator is likely to make a decision there. Is KT pushing for lifting up handset subsidy there on all handset classes including recurring CDMA EVDO type handsets as well?

And finally I guess that SKT Telecom has announced recently that they are in active discussions in India and they may expect to make a formal announcement within six months. There were speculations in the past of KT looking at the Indian market. Can you just comment about whether SKT's move would make KT more proactive in terms of globalization or -- and we as analysts and investors pretty much discount any possibility of KT [inaudible].

Oh yes when PowerCom enters the market there will be some impact to KT however as the market predicts, we do not think that this is going to be a big shock to KT. The reason is this; because the retail markets that PowerCom will serve as geographically there is a long distance between the areas that KT serves and the competition will mostly be triggered between PowerCom and cable TV [also].

Your question with respect to how we're going to control the marketing spending, yes there is some difficulty. Up to now KT has managed mostly based on its sales targets but with the inauguration of the second term of the privatized KT coming up just around the corner, we're going to put more focus on the improvements of the ARPU rather than just focusing on increasing the sales. So we want to make internally a very sound company, and that has been voiced by the newly appointed candidate president as well. And rather than fostering some fierce competition we wish to utilize KT's strength which is providing high quality services as well as hi-tech technologies and services as well. And in the second quarter one of the reasons why we incurred a lot of marketing spend is because we were preparing to counter the entrance of the PowerCom and other entrants coming into the market.

So from third quarter we're going to focus more on service dependent differentiated strategy and since we have already spent quite a bit in the second quarter we see that there will be less spending occurring in the third quarter.

With respect to handset subsidies, for [ybrow] which is a new service because the market is in a formation stage I believe handset subsidy is needed for that type of handset. However for EVDO the market already is quite big so for here I think handset subsidies are unnecessary.

We have no investment plan for India however we will continue to look for and discover global opportunities with respect to our strength which is broadband and CDMA.

The next question comes from [inaudible] of [inaudible] Asset Securities.

[Inaudible question - microphone inaccessible].

Can you break down your marketing expenses by business line? That's the first question.

The second question is in the second half of the year I believe your marketing activities will be more of a defensive strategy rather than an offensive strategy in the second half of the year and I think there are going to be fierce competition with the [SOs] in the broadband stakes. Can you give us your insight on that?

And also third, you said you would increase ARPU. How do you plan to do that?

And the fourth question is with respect to IPTV the MIC and the Broadcasting Commission has not yet reached any type of a decision, but I think a lot has taken place with respect to IPTV within KT and [Hanora]. Can you give us your update on what progress there has been within your company?

With respect to the marketing expenses by business line, because the marketing expenses are closely related with our sales activities it's very difficult for us to break down and give you the exact number for each of the business lines. And I think though it's safe to say that we have spent more in areas where there is more competition such as broadband, [PCSV] sales and telephones.

Since the second half as you have correctly pointed out, we are going to be more defense focused rather than being offensive.

With respect to our plans to increase ARPU, whether we have detailed plans to do that, we are going to conduct an in-depth analysis of our subscriber base. We will analyze it by location and income bracket to provide customized products to the subscriber base. Especially for instance like people living in big cities with children and for them we will provide high speed products. And also IP sharing routers have now been openly allowed so we will capitalize on this opportunity.

With respect to your question about IPTV, yes it is true that various government authorities have different positions and right now the broadcasting commission is undergoing an organization reshuffling, therefore it's taking a longer time for them to establish a telecommunication and broadcasting commission than expected.

As you can see from cases from other countries, when you want convergence of telecommunication and broadcasting without the participation of telecom operator, they cannot be complete and it cannot happen. [inaudible] SOs are providing broadband connection services we believe that we should also have opportunity to make use of our own network, we meaning the telecom operators, so that we can maximize the efficiency of the resources.

You have mentioned that [Hanora] is very quick in preparing for IPTV. I could say for KT that all preparations are complete within our company as well but compared to [Hanora] the government has a close watch on what KT is doing and KT's movement so we wish to commercialize only after government policies are finalized.

The next question comes from [inaudible] of Merrill Lynch. Hello? The next question comes from [Mitchell Kim] of Morgan Stanley.

Good evening this is Mitchell Kim. I have actually multiple questions so first -- I have actually four questions but they're going to be relatively short so please be patient. My first question is on labor costs. I know that you did mention that you want to try to bring labor costs to 20% of sales. Can you be a little bit more specific about your action plan? What are some of the things that you can do to achieve that target, and exactly when do you think you could achieve that 20%? Because right now, and ever since 2003 labor costs have been rising steadily once again so I think that is a critical point.

Secondly I know that you touched on marketing costs but it just -- I'm still puzzled as to what areas that are you spending in preparation for PowerCom's entry. On PCS resale, the gross adds were actually lower in the second quarter than first quarter and PowerCom has not really launched their broadband service yet so what is the anticipation of PowerCom's [inaudible] exactly? If you could give me some of the examples that some of the promotions that you're running I think that would be very helpful.

And third question is on sales commission. What do you think is going to happen in the second half because sales commission was up 45% on a year on year basis. I know it had to do with your ex-employees that were re-hired back. As I understand in the second half the contract expires so could you just confirm whether that is the case? And then you expect that sales commission costs will be to decline?

And lastly on bad debt, your bad debt provision is actually much lower than what you did last year first half. Is your bad debt situation improving and hence you are making lower provision? And is that [term] likely to continue in the second half? If you have some sort of a guidance for bad debt provision for this year that would be appreciated. Thank you.

On the action plan to contain labor costs to below 20% of the sales, this very item is -- there is a big [homework] for the second term management for KT, the second term of the privatized KT. This is an area where the new CEO and the management are concentrating their effort to overcome however at this point we do not have anything specific to show for our concerted efforts to relieve or overcome this problem.

On the second question when PowerCom entered the market the competition will not be between PowerCom and KT but more between PowerCom and cable TV modem operators who use PowerCom's line. Therefore our strategy was to make sure that before PowerCom enters the market that we conduct our marketing activities quite aggressively against the users of cable modem operators. That is why KT had to [inaudible] [festivals] and have various different types of promotional events and that is one of the reasons why in the second quarter they have had significant promotional expenses.

And on your third question -- sorry and in the second half of the year we will continue to control the marketing [inaudible] as I said previously. And in the third quarter as you said the sales -- as you correctly mentioned the sales commission will decrease and in the third quarter the amount will be 90 billion and in 4Q it will further decrease to 70 billion won.

Your fourth question with respect to bad debt provisioning, it's been a while since we have focused into on this issue but we have seen a very smooth recovery of the receivables and smooth recovery. And in the second half therefore we will see that the increased rate is going to be smaller than 2004 numbers and this year we think the amount will be below 150 billion Korean won.

Thank you.

The next question comes from [Alistair Scarr] of Merrill Lynch.

Thank you very much. I apologize if I ask questions that have been asked before, I've been dropping in and out of the conference. Just a couple of questions please.

One, I'm a bit puzzled in terms of your strategy going forwards first on the broadband side. You talk about emphasizing the quality of your products and the certification of your network and then you seem to have had to throw marketing dollars in the plate of relatively what you could describe as second tier of competition coming from PowerCom and [ESO]. Are you basically saying that broadband is now a commoditized product in Korea and therefore are you seeing any pressure on the revenue line in broadband? So what sort of broadband growth do you think with the revenue line you've got or is there pressure on that line?

The second question and apologies if you've covered this already, in terms of guidance for 2005 to what extent has the change in labor terms [inaudible] affected your guidance outlook? And if it has then why has it? Why are you in a weak negotiating position when it comes to labor costs? You already state that the cost of your employees is at European levels; you're paying well above other sector companies so why is there this constant upward pressure on the labor costs?

Thirdly looking at your cost of goods sold, I can obviously see an offsetting revenue line for the handset sales on the [PT] side. Could you just tell us what the revenue is for the line other items of PDA and wireless LAN cards etc? Is there any element of subsidy in there?

And finally a very general question. In terms of the new CEO strategy, have you any sense as to his approach to generation of growth and top line growth versus capital return etc? Thank you.

The broadband market in Korea has already reached a very high point in penetration and so I think we can say that with respect to broadband services we have entered a stagnant period. So it's very important to maintain the broadband subscriber base's loyalty to the company and migrate low quality product uses to high quality products and make sure that the upgrades are level. And as a way to increase our ARPU, I have mentioned the use of the IP sharing routers. By allowing this and making it a peak service, we can further grow the market. So if I were to answer your question whether I think the broadband market has become commoditized I would have to answer it by saying yes.

In terms of labor management relationship whether KT -- you have pointed out that KT's management is too weak against the labor union. You must understand the special situation that Korea is in, especially with respect to the labor market. There are many difficulties and tribulations. But KT management by no means have [opposition] against the labor union, it's just that the labor union has voiced its position that rate increases in KT were relatively low up to this year and because there will be an election for labor union members by the end of the year they have made a strong request for an increase in wages. And that was the basis leading to the agreement between the labor and the management.

To add on that note, the labor market in Korea, the flexibility of it is quite low and the labor union executive body is going to have an election at the end of the year, that's why they strategically had a list of items which they strongly demanded against the management. But if you look at the outcome we did not increase the basic pay, it is more of a one-off expenditure therefore it is not going to have a long term effect on our labor costs. Of course it did bring about an increase in the labor cost this year. The labor union has demanded a number of things based on the fact that they did not create any dispute for a couple of years and for their aggressive participation in the privatization process. And also they demanded for some compensation because they bought their ESO, employee stock options -- they bought their employee stocks at a quite high stock prices but now the stock prices have decreased. So they are asking for compensation as a differential.

Third, on your question about costs, cost of goods sold, you said that there is no increase in other areas but it's mainly because of an increase in the sales in [one phone] and [inaudible] which is where there is no breakdown on that on the sheet.

And on the new CEO's future strategy, he is in the process of detailing out his management philosophy at this point and I am sure that he will make it known once he is inaugurated, however personally by talking to our newly designated CEO, I think his position is that it's true that we cannot ignore top line growth however our focus will be more on internal [inaudible] so rather than trying to add on more subscribers, he believes providing better value to the existing subscriber base thereby bringing about an increase in ARPU is more important.

The next question comes from [inaudible] of Goldman Sachs. Hello?

The next question comes from [inaudible] of Lehman Brothers.

There are currently two participants with questions waiting right now.

Yes the next question comes from [inaudible] of [inaudible] Securities.

What is your dividend ratio and cash dividend payout as well as [inaudible]?

On dividends we will continue and maintain our dividend policy which we had up to the point and in order to start quarterly dividend payouts we have to revise our Articles of Incorporation. We are listening to the demands of the investors and we will review the situation and we will make a decision next year.

With respect to cash payout we have up to 49% foreign [inaudible] ownership limits, we have used up all the limit. Therefore other than treasury share cancellation there is no other countermeasure other than cash payout. Therefore our dividend payout will mostly be in the form of a cash payout.

Currently there are no participants with questions. [OPERATOR INSTRUCTIONS]. The next question comes from [inaudible] from ABN Amro.

I wasn't able to take part from the very beginning so maybe I can make a couple of [observations]. So I would like ask questions on a number of items.

I would like to confirm a couple of expense items. You have given us a second half guidance on sales commission but I think people are more concerned about the sales promotion line item. And as far as I know this amount is paid out to the employee and so can you give us a guidance on that number for the second half of the year?

The second question is on repair and maintenance line item. Of course compared to last year this expense is under control however compared to first quarter of the year the amount has not improved, so can you give us your predictions on that?

The third is on bad debt provisioning. If I heard right I think you said the amount is 150 billion Korean won. If that is the case, in the second half [inaudible] billion in bad debt provisioning, why so significant? [inaudible] question.

The fourth question is on equity method devaluation and non-operating expense line items. Can you give us your explanation on that?

And the fifth is do you have plans to pay out employee share -- trigger shares to your employees?

We will do our best to reduce the promotion expenses compared to last year and also the same goes for repair and maintenance.

On the bad debt provisioning and allowance usually it's the case that the amount gets provisioned more in the second half of the year but it will not be more than 100 billion; if the situation is positive it will definitely be less than 100 billion Korean won.

And the equity method assessment is -- we believe that the outcome is going to be positive and we will pay out 60 shares per person to the employees as ESOPs. And on our treasury shares we are going to manage it quite flexibly and at this point we do not have a clear plan when to distribute the ESOPs or whether we would have another pay out of shares in the future.

The next question comes from [John Kim] of Merrill Lynch.

Thank you for the call. A couple of questions. First I think most of us realize that KT has a very inconsistent track record in terms of keeping its costs stable and I understand from this call that you'd like to focus on keeping your costs under control for the remainder of the year. Could you please share specifically what different measures are in place to ensure that it will be different this time around?

Second question, can the management actually share some information or insight if there is a specific return on investment target that you have on your CapEx programs for your new services or technology such as IPTV or [ybrow].

And then finally going back, apologies for dwelling on your marketing but as I recall in your previous answer you mentioned that you'd spent on your sales promotion to actually target on acquisitions of subscribers who are currently on cable modem service. However if you actually match your sales promotion cost to your broadband service revenues, this actually shows that your sales promotion costs actually went up dramatically while your broadband revenues actually stayed flat. So does that actually mean that KT has endured a lot of existing subscriber churn while you may actually have had some success in turning in some new subscribers who are a [sole] customer. Thank you.

On your point about inconsistency and [inaudible] as the CFO it is very regrettable that there was such inconsistencies but in the second half I believe we can do away with this inconsistency [inaudible] because our focus is going to change. We are no longer going to focus on the pure size but we will put more concentration on strengthening the [sales] internally and this will enable effective control of costs. Before, KT has placed too much focus on just increasing sales so even at the expense of additional cost our priority target was increasing sales and revenue but that focus is going to shift so I believe that shifting the focus is going to help us do away with such inconsistency.

On ROI on new services such as [ybrow] once the service enters a mature stage I think we can achieve ROI of more than 13% but of course this 13% cannot be achieved immediately. We will have to wait until the business matures.

On marketing costs, it was not [inaudible] just to prepare against the cable TV operators. As I said before we had spent marketing costs mostly on services where there is quite a bit of competition such as broadband, PCS resell and telephone services. There were a lot of costs that went in in order to maintain the subscriber base.

One example of such activity is we have put in a lot of effort to make sure that the subscriber who is nearing their contract expiration date, we put in a lot of effort to make sure that they re-entered the contract.

Sorry there are no other participants listed.

Thank you very much for your participation. We will take all your comments and we will make sure that your comments and opinions are well respected in our management. Thank you very much.