Earnings Call: H1 2020

Aug 26, 2020

Good afternoon, ladies and gentlemen. I am Terence of China Communications Services. On behalf of the management, I would like to welcome you to our 2020 interim results audio webcast. First, our management will present 2020 interim results, and a Q&A session will follow. If you would like to raise questions during the presentation, please input them on the webpage. I will read all your questions following our management presentation. They will answer your questions and I will provide consecutive interpretation. Let me introduce our management who are with us today. Chairman Zhang Zhiyong. President Si Furong. Executive Vice President Liang Shiping. Executive Vice President and CFO Ms. Zhang Xu. Thank you for joining, and I hope you will find this presentation helpful. Next, let us invite our Chairman Zhang to present the 2020 interim results overview. Thank you, Terence. Good afternoon, ladies and gentlemen. Due to the coronavirus pandemic, this presentation is still conducted online. Hope we can meet you again at the next presentation after the pandemic ends. Today's presentation is divided into three parts. First, I will introduce the overview of our results. Next, Mr. Si and Madam Zhang will present the business review and financial results respectively. During the Q&A session, we will answer the questions that you may concern. First, we look at highlights. In first half 2020, COVID-19 brought unprecedented impact to the macro economy, various industries, and the company. Our operating results experienced short-term fluctuation. Facing the pandemic, we adopted multiple measures to promote resumption of work and production. As the pandemic stabilized domestically, our operation in the second quarter rebounded noticeably. Revenue increased by over 26% compared to the first quarter. Net profit in the second quarter also improved significantly versus the first quarter. We proactively seized opportunities from 5G construction by domestic operators, cultivated and leveraged our edges in general contracting to consolidate our leading market position. Growth trend of domestic non-operator market sustained. The market continued to be the main growth driver of overall development, contributing over 40% of total revenues for the first time with improving development quality. We continuously increased R&D investment to upgrade our software service capabilities. ACO business maintains robust growth and contributed approximately 15% of total revenues. Our businesses and capabilities tally with new infrastructure and accelerated demand for digital upgrade of society and industries. We will seize the opportunities and promote a high quality and continuous development. Next, let us look at overall results. Our results have been maintaining stable growth in recent years, but were affected by the pandemic in the first half. Revenue amounted to CNY 53.8 billion, decreased 4% year-on-year. Net profit amounted to CNY 1.6 billion, decreased 7.2% year-on-year. Because of the pandemic, most of our businesses could not be conducted normally. The progresses of project development and construction were affected and tendering was deferred, especially in February and March. Domestic non-operator market and domestic operator market as well as various businesses showed downward trends. Revenue in the first quarter decreased by 15.3% year-on-year. Facing the challenges, we adopted various measures to proactively promote resumption of work and production. On one hand, we adopted supplemental measures such as online and remote to promote digital transformation of enterprises in which communication, marketing, and operation go online as well as delivery, management, and security surveillance becoming remote. We overcame the challenges of cross-regional delivery and marketing to fulfill the internal control and customer demand. On the other hand, we focus on new contracts, production volume since work resumption, tender volume, key projects, key companies, and major customers, and strengthen process supervision. Meanwhile, we increased investment in R&D, enhanced risk prevention, optimized operation, and persisted in cost control to raise efficiency for development. With our continuous effort and relatively stable pandemic situation in China in the second quarter, revenue showed a noticeable rebound compared to the first quarter, up by 7.4% year-on-year, and the growth was higher than China's GDP growth in the same period. It also laid a solid foundation of good management and capabilities for long-term development. In the difficult external environment in first half 2020, though the quick recovery in the second quarter could not fully mitigate for the fall in the first quarter, on the basis of less than three months effective operation, we managed to achieve commendable operating results. Domestic non-operator was the first that resumed positive growth, and ACO business became the main growth driver, benefiting from increased investment in R&D, continuous investment, and experience accumulation in the informatization for serving the society in recent years. We can say the deployment in recent years enabled us to better cope with the unfavorable conditions of relatively significant decline in domestic operator market, TIS and BPO businesses, and maintained the steadily improving trend in operation. Amidst the pandemic, we insisted life come first and put the life, health, and safety of our employees as the first priority. We achieved zero transmission within the company and zero infection in overseas business regions. The above achievement is not easy to come for a group with over 90,000 employees and its business in over 40 countries across the globe. We made a lot of contribution to pandemic prevention, which increased our cost substantially. However, we overcame difficulties, controlled costs, enhanced efficiency, such that various costs were reduced obviously. Meanwhile, we assumed responsibility of a state-owned enterprise and hastened to the front line of combating the pandemic with a united spirit. We ensured the construction of a series of infrastructure and smooth communication at Huoshenshan Hospital and Leishenshan Hospital in Wuhan, ensured timely delivery of communications equipment and supplies to infected areas, leveraged CCS Yun, IoT, big data, and other foundation platforms to develop over 40 smart applications for pandemic prevention, and donated masks and other pandemic prevention supplies to infected areas. We overcame difficulties, controlled costs, and enhanced efficiency, such that various costs were reduced obviously. The pandemic prevention work fully reflects our organization capability, convening power, leadership, and execution. While we see the short-term impact posed by the pandemic, we also see the defining changes on customer demand, operation model, and people's lifestyle and vast opportunities brought by it. Chinese government vigorously promoted new infrastructure, including 5G, leading to the need for a general contractor of new digital infrastructure to fulfill new market demand, which bring us ample development opportunities. According to different research institutes in the industry, new infrastructure will induce a trillion or even 10 trillion market potential. Currently, in the seven key areas of new infrastructure, we have been deeply involved in construction of 5G and data centers, and vigorously explore into opportunities in IoT and AI. We explore the integration demand and potential in digitalization and traditional infrastructure, such as extra high voltage supply system and urban rail system. Meanwhile, new infrastructure also brings us huge opportunities, mainly on, first, digitalization of traditional infrastructure and integration of new and traditional infrastructure. Second, new infrastructure enables digital transformation of society and industries accelerate, facilitates new technologies such as AI to deeply integrate with real economy, bringing the new market of intelligentization of social governance and applications of people's livelihood. Third, operators accelerate their transformation. General contracting service model in 5G and data centers, new operations and new business in cloud network integration bring new opportunities in digital services. In addition, overseas demand for communication in infrastructure construction and digitalization construction is still very strong. In future, we position as new generation integrated smart service provider and play the role of builder of digital infrastructure, provider of smart products and platforms, service provider of data production, and guard of smart operation. We will focus on the three main tracks of development in domestic operator, domestic non-operator, and overseas markets to expedite value transformation. We believe the impact of our company by the pandemic is only temporary. There is no change in the fundamentals and the long-term prosperity trend. There will be more opportunities than challenges. Our management team will insist development with confidence, cultivate new opportunities, begin a new stage, work hard on development and transformation, and facilitate the company in marching towards high-quality development. Above is the first part of the presentation. Next, let's invite President Xie to present the business review in the first half. Thank you. Thank you, Chairman. Ladies and gentlemen, good afternoon. I will present the group's business performance for first half 2020. The table shows the revenues and growth rates of the three business segments and percentage to total revenues of each segment in first half 2019 and first half 2020. In first half 2020, the impact caused by the pandemic on TIS business and supply chain in BPO business was relatively obvious that the respective revenues declined. Maintenance and property management in core BPO remains stable. In recent years, we have increased investment in R&D consistently to forge smart product portfolio successfully, leading to the sustained double-digit growth in ACO business, in which the growth of software development and system support business was over 20%. In first half 2020, business structure and market structure were further optimized. On business composition, portion of revenue from ACO business continues to rise and increased to approximately 15%. On market composition, portion of revenue from domestic non-operators continued to rise and exceeded 40%. To seize opportunities from digital economy and smart society, in recent years, we consistently strived to look into the needs of customers in vertical industries, increased investment in R&D, and early deployed in software and digital service capabilities. Amid the pandemic, our effort is bearing fruit. Contributed by smart products and solutions, domestic non-operator market was the first market which overcame the pandemic impact and maintained positive growth at 3.7% year-on-year, of which ACO business maintained a robust growth and was the main revenue growth driver. Meanwhile, we achieved major breakthroughs in the field of data center, emergency management, Smart Game, electricity, and transportation. The proportion of new contracts in the domestic non-operator market, with a size of over CNY 100 million per contract, increased from 8% in 2019 to 14% in the first half this year. Well, as you can see, the working period in the first half was effectively less than three months. The decline in gross profit margin of domestic non-operator market further moderated, and development quality of the market was further enhanced. The pandemic affected the overall development in the domestic operator market, in particular, the project construction. Revenue from the market declined. The market declined 9.2% year-on-year. We continued strengthening dual growth drivers plus strategy. On one hand, we seized opportunities from 5G investment and co-built and co-shared by domestic operators. We have set up dedicated project management teams, strengthened our capabilities, and expanded the 5G construction business by adopting a new general contracting model, leading to an increase in related project volume. On the other hand, we deeply penetrated the OPEX businesses while supporting the transformation of domestic operators with smart services and applications. As a result, BPO business was relatively steady, and ACO business sustained growth in first half 2020. In first half 2020, development of major overseas projects was successful. Most projects in Nepal, Saudi Arabia, Mali, the Republic of the Congo, generated revenue. Contributions from Asia Pacific, Southeast Asia, and the Middle East continues to increase. Revenue from overseas market resumed growth, up 7.3% year-on-year. We will seize opportunities from in-depth promotion of the Belt and Road with a focus in key regions and projects to seek breakthroughs. Meanwhile, due to the severe pandemic situation overseas, we will further optimize business management, enhance capabilities in service and risk prevention. New infrastructure led by 5G is making an impressive debut. As 5G integrates with various industries and develops, 5G relevant investment from domestic operators will increase gradually. Of which, in short term, 5G construction investment will be mainly from domestic operators, which will induce domestic operators' CAPEX to resume growth. To prepare for 5G construction growth period, we will implement the below measures. First, leverage 5G general contracting to forge the new EPC general contracting capabilities. We will leverage centralized procurement to procure at competitive prices to lower cost and enhance efficiency. Through general contracting, we will expand market share to consolidate our leading market position. Second, forge 5G plus capabilities. Domestic operators further accelerate business transformation. We will support them to connect with vertical industries by providing enterprise-dedicated network service and industrial smart applications. Third, explore cloud network integration opportunities. We will capitalize on the trend of cloudification of 5G network, help operators construct efficient network management and operation and maintenance system to seize new opportunities from smart maintenance of 5G and IoT. 5G network construction has very strong spillover effect, which will drive investment growth, boost digital consumption, and further penetrate into various industries and sectors. Well, a few years ago, we communicated with you that we'll not only focus on investment from operators, but also from industry. Also, the society's attention on digitalization was aroused by the pandemic, which will expedite digital transformation of society and industries. To seize opportunities in post-pandemic era, we set up China Comservice General Research Institute, increased R&D investment on foundation platforms, including CCS Yun, CCS IoT platform, and network security service platform. Based on foundation platforms, we will enhance middle platform construction, including R&D, digital, and business middle platforms. We will coordinate resources and core capabilities on middle platform and enhance our competitive advantages. In addition, we will continuously enhance internal and external symbiotic ecosystem, enlarge the cooperation in technology, products, channels, and industry finance, strengthen symbiotic synergistic cooperation, and leverage ecosystem to develop market. Now, we already have over 30 industrial solutions targeting different sectors and industries. We will grasp the window of opportunities to provide customers with standardized and customized comprehensive smart solutions. With a focus on key sectors such as government, transportation, electricity, game, and emergency management. As a major constructor of data centers, we have been maintaining our leading market position. We provide data center construction and professionally integrated service for domestic operators and internet companies, constructing about 1 million racks. We possess top industry qualification in design, construction, and supervision and multiple patents. We utilize self-developed technologies to construct customized and standardized data centers through efficient deployment and help customers reduce energy consumption and costs. With years of experience in data center construction, we signed many sizable data center projects with size over CNY 100 million in first half 2020. New contract amount grew strongly and doubled to over CNY 4 billion. Industrial internet is one of the key areas of new infrastructure. We possess integrated service capabilities in that area. We formed industrial internet ecosystem alliance with our partners. Starting from top-level planning, we construct industrial internet for government, parks, industries, and enterprises. We also participate in national innovative projects and undertake national standard formulation, deployment, and planning on industrial internet. For other new infrastructure, we focus on key industries and adopt flexible cooperation models such as network plus AI application integration to partake AI network infrastructure construction. On one hand, we timely capture the new development features of extra high voltage, rail transit, and new energy vehicle. By supporting the digital transformation of relevant enterprises, we explore their informatization demand. By providing consultancy services, we explore new opportunities in related businesses. In the recent two years, we had many smart application cases that integrate advanced technologies in transportation and electricity. As introduced by Chairman Zhang in the former part, development in new infrastructure will need EPC general contractor of new digital infrastructure, and customers will have keen demand on integrated services. In first half 2020, we provided 5G construction services through general contracting to domestic operators successfully. We will leverage 5G general contracting to enhance coordination capabilities, increase project value, restructure business model by establishing cross-department and cross-profession processes in design, construction, product procurement, finance, and subcontracting with an aim to forge EPC general contracting capabilities. We will expand our general contracting business in 5G, IDC, ICT, and overseas with a view to be the largest new infrastructure ICT area service provider in the PRC. As a new generation integrated smart service provider, we will assume the below four responsibilities. As the builder of digital infrastructure, facing the opportunities from digitalization of traditional infrastructure, new infrastructure such as 5G, and integration of new and traditional infrastructure, we will accelerate reconstruction of capabilities such as general contracting to provide digital infrastructure that fulfills development needs for society and industries. As provider of smart products and platforms, leveraging foundation platforms such as CCS Yun and dispersed R&D, we will expedite our own digital transformation and enable customized, fragmented, and quick iteration demand of society and industries. As the service provider of data production, leveraging big data, we will coordinate internal and external data production processes. Playing the role of expert and consultant, we will serve and lead the production of customers and integrate into customers' value chain, innovation chain, and ecosystem. In the Internet of Things era, network maintenance and security businesses will be seeing an explosive growth. At the guard of smart operation, we will provide customers with multidimensional, integrated, and efficient smart maintenance service, as well as fast and comprehensive local support service. In sum, we are devoted to provide cross-platform, cross-connection, cross-application, cross-region, cross-supplier, full lifecycle comprehensive smart services for the society. For society, industries, and customers to create greater value for customers. Above is the business overview. Next, let's invite CFO, Madam Zhang, to present the financial review in first half 2020. Thank you, President Xie. Good afternoon, ladies and gentlemen. I will now present the financial review for first half 2020. The table shows our key financial indicators, such as revenue, cost, and profit for your reference. In the first half, the company implemented multiple cost control measures such that most costs decreased by different degrees year-on-year. In first half 2020, the company's cost of revenue accounted for 89% of total revenues, up by 0.2 percentage point compared with the same period of last year. Amid the pandemic, the company adopted multiple measures with strict cost control and achieved favorable results in the first half. We utilized subcontracting resources adaptively and controlled total staff number. Direct personnel cost as a percentage of revenue kept declining. We continued to control the product's distribution business. Direct cost of product distribution continued to fall. The company continued to intensify subcontract management through in-depth data analysis on subcontractors and strengthening the management and supervision over the whole subcontracting process. Subcontracting cost was controlled effectively with its growth as a percentage of revenue further moderated. The rapid growth of system integration business in domestic non-operating market also drove increase in materials cost. Regarding operating efficiency, despite negative factors such as the pandemic and declining service value in telecom industry, we reduced cost and increased efficiency through steadily improving the development quality of domestic non-operator market, optimizing business structure, strict cost control, and business expansion through general contracting model. The decline of gross profit margin noticeably moderated and gross profit margin was 11%. The company continued to increase R&D investment to upgrade software service capability and enrich the portfolio of smart products. R&D expense as a percentage of revenue increased by 0.2 percentage point to 2.6%. The pandemic affected the operation of our businesses, with some costs such as labor costs and certain SG&A expenses being relatively fixed in nature, and also the cost increase related to pandemic prevention, net profit margin experienced a decline. In first half 2020, the pandemic posed a significant impact on the domestic macro economy, and we encountered more pressure in cost, cash collection, and payment, as well as cash flows. Thus, free cash flow decreased year-on-year. The pandemic delayed project implementation and delivery, revenue recognition and billings were deferred, and usual communication with customers were affected. Thus, payment by most of the customers had been slower than the past. Regarding accounts payables, we mostly continued to pay subcontractors and SMEs strictly following the contracts per requirement of the government, and the pandemic also affected our pace of payment. Accounts payable turnover days increased. With impact of the pandemic wearing off and taking our general cash flow pattern in the first half and second half into account, cash flow is likely to see a recovery in the second half. Given the relatively large uncertainty in the macro environment over the year and the larger need for working capital for the expansion of general contracting projects such as 5G, we expect free cash flow for the year will face more pressure than the past. We will continue to adhere to the value-driven principle and strengthen the management of working capital endeavor to maintain healthy financial position. The table lists out the key indicators of company's balance sheet for your reference. As of June 30, 2020, our total assets were RMB 88.2 billion. Cash and deposits were RMB 17.5 billion. Liabilities to asset ratio and debt to capitalization ratio were 60.1% and 1.8% respectively. We have always maintained low interest-bearing debt and net cash level. The company's financial position remains solid and healthy, which enables us to withstand the challenges brought by the changes in macro environment, supports the continuous business development and transformation, as well as providing sound support for the advancement towards high-quality development. For more detailed financial position, please refer to our results announcement. Now we are very pleased to answer your questions. Thank you.