20-F 1 d20f.htm FORM 20-F Form 20-F

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

¨ Registration statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934

or

 

x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2010

or

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             

or

 

¨ Shell company report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Date of event requiring this shell company report

Commission file number 001-31731

 

 

Chunghwa Telecom Co., Ltd.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Taiwan, Republic of China

(Jurisdiction of Incorporation or Organization)

21-3 Hsinyi Road, Section 1, Taipei, Taiwan, Republic of China

(Address of Principal Executive Offices)

Fufu Shen

21-3 Hsinyi Road, Section 1, Taipei,

Taiwan, Republic of China

Tel: +886 2 2344-5488

Fax: +886 2 3393-8188

(Name, Telephone, email and/or Facsimile number and Address of Company Contact Person)

 

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Shares, par value NT$10 per share

American Depositary Shares, as evidenced by American Depositary Receipts, each representing 10 Common Shares

 

New York Stock Exchange*

New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

 

 

Indicate the number of outstanding shares of each of the Issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

7,757,446,545 Common Shares

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨     

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  ¨    International Financial Reporting Standards as issued by the International Accounting Standards Board  ¨    Other  x

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. Item 17  ¨    Item 18  x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    Yes  ¨    No  x

 

* Not for trading, but only in connection with the listing on the New York Stock Exchange of the American Depositary Shares

 

 

 


CHUNGHWA TELECOM CO., LTD.

FORM 20-F ANNUAL REPORT

FISCAL YEAR ENDED DECEMBER 31, 2010

TABLE OF CONTENTS

 

 

          Page  

SUPPLEMENTAL INFORMATION

     1   

FORWARD-LOOKING STATEMENTS IN THIS ANNUAL REPORT MAY NOT BE REALIZED

     1   

PART I

     2   

ITEM 1.

  

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     2   

ITEM 2.

  

OFFER STATISTICS AND EXPECTED TIMETABLE

     2   

ITEM 3.

  

KEY INFORMATION

     2   

ITEM 4.

  

INFORMATION ON THE COMPANY

     15   

ITEM 4A.

  

UNRESOLVED STAFF COMMENTS

     64   

ITEM 5.

  

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     64   

ITEM 6.

  

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     88   

ITEM 7.

  

MAJOR STOCKHOLDERS AND RELATED PARTY TRANSACTIONS

     97   

ITEM 8.

  

FINANCIAL INFORMATION

     98   

ITEM 9.

  

THE OFFER AND LISTING

     99   

ITEM 10.

  

ADDITIONAL INFORMATION

     102   

ITEM 11.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     117   

ITEM 12.

  

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     119   

PART II

     122   

ITEM 13.

  

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     122   

ITEM 14.

  

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     122   

ITEM 15.

  

CONTROLS AND PROCEDURES

     122   

ITEM 16A.

  

AUDIT COMMITTEE FINANCIAL EXPERT

     125   

ITEM 16B.

  

CODE OF ETHICS

     125   

ITEM 16C.

  

PRINCIPAL ACCOUNTANT FEES AND SERVICES

     125   

ITEM 16D.

  

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     126   

ITEM 16E.

  

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     126   

ITEM 16F.

  

CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     126   

ITEM 16G.

  

CORPORATE GOVERNANCE

     126   

PART III

     129   

ITEM 17.

  

FINANCIAL STATEMENTS

     129   

ITEM 18.

  

FINANCIAL STATEMENTS

     129   

ITEM 19.

  

EXHIBITS

     129   

 

i


SUPPLEMENTAL INFORMATION

All references to “we,” “us,” “our” and “our company” in this annual report are to Chunghwa Telecom Co., Ltd. and our consolidated subsidiaries, unless the context otherwise requires. All references to “shares” and “common shares” are to our common shares, par value NT$10 per share, and to “ADSs” are to our American depositary shares, each of which represents ten of our common shares. The ADSs are issued under the deposit agreement, as amended, supplemented or modified from time to time, originally dated as of July 17, 2003, among Chunghwa Telecom Co., Ltd. and the Bank of New York, and amended and restated on November 14, 2007, among Chunghwa Telecom Co., Ltd. and JP Morgan Chase Bank, as depository, and the holders and beneficial owners of American Depositary Receipts issued thereunder. All references to “Taiwan” are to the island of Taiwan and other areas under the effective control of the Republic of China. All references to “the government” or “the Republic of China government” are to the government of the Republic of China. All references to the “Ministry of Transportation and Communications” are to the Ministry of Transportation and Communications of the Republic of China. All references to the “Securities and Futures Bureau” are to the Securities and Futures Bureau of the Republic of China or its predecessors, as applicable. “R.O.C. GAAP” means the generally accepted accounting principles of the Republic of China, and “U.S. GAAP” means the generally accepted accounting principles of the United States. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding. Unless otherwise indicated, or the context otherwise requires, references in this annual report to financial and operational data for a particular year refer to the fiscal year of our company ending December 31 of that year.

When we refer to our “privatization” or our being “privatized” in this annual report, we mean our status as a non-state-owned entity after the government reduced its ownership of our outstanding common shares, including our common shares owned by entities majority-owned by the government, to less than 50%. We were privatized in August 2005.

We publish our consolidated financial statements in New Taiwan dollars, the lawful currency of the Republic of China. In this annual report, “NT$” and “NT dollars” mean New Taiwan dollars, “$,” “US$” and “U.S. dollars” mean United States dollars.

FORWARD-LOOKING STATEMENTS IN THIS ANNUAL REPORT MAY NOT BE REALIZED

This annual report contains forward-looking statements, including statements regarding:

 

   

our business and operating strategy;

 

   

our network expansion plans;

 

   

our business, operations and prospects;

 

   

our financial condition and results of operations;

 

   

our dividend policy;

 

   

the telecommunications industry regulatory environment in Taiwan; and

 

   

future developments in the telecommunications industry in Taiwan.

These forward-looking statements are generally indicated by the use of forward-looking terminology such as “believe,” “expect,” “anticipate,” “estimate,” “plan,” “aim,” “seek,” “project,” “may,” “will” or other similar words that express an indication of actions or results of actions that may or are expected to occur in the future. These statements reflect our current views with respect to future events and are subject to risks, uncertainties and assumptions, many of which are beyond our control. You should not place undue reliance on these statements, which apply only as of the date of this annual report. These forward-looking statements are based on our own information and on information from other sources we believe to be reliable. Actual results may differ materially from those expressed or implied by these forward-looking statements. Factors that could cause differences include, but are not limited to, those discussed under “Item 3. Key Information—D. Risk Factors.” In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this annual report might not occur and our actual results could differ materially from those anticipated in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

 

1


PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

We were privatized as a result of a secondary ADS offering and concurrent domestic auction of our common shares on August 12, 2005. The privatization has enabled us to develop our business and respond to changing market conditions more rapidly and efficiently.

A. Selected Financial Data

The selected income statement data and cash flow data for the years ended December 31, 2008, 2009 and 2010, and the selected balance sheet data as of December 31, 2009 and 2010 set forth below are derived from our audited consolidated financial statements included elsewhere in this annual report and should be read in conjunction with, and are qualified in their entirety by reference to, our consolidated financial statements and the related notes. The selected income statement and cash flow data for the years ended December 31, 2006 and 2007, and the selected balance sheet data as of December 31, 2006, 2007 and 2008 set forth below, are derived from our audited consolidated financial statements not included in this annual report. The consolidated financial statements have been prepared and presented in accordance with accounting principles generally accepted in the Republic of China, or R.O.C. GAAP, which differ in some material respects from accounting principles generally accepted in the United States of America, or U.S. GAAP, as further explained under note 36 to our consolidated financial statements included herein.

 

     Year Ended December 31,  
     2006(1)     2007(1)     2008(1)     2009     2010  
     NT$     NT$     NT$     NT$     NT$     US$  
     (in billions, except for percentages and per share and per pro
forma ADS data)
 

Income Statement Data:

            

ROC GAAP

            

Net revenues

     184.5        197.4        201.7        198.4        202.4        6.9   

Operating costs(1)

     (93.8     (106.7     (113.5     (112.7     (115.3     (3.9
                                                

Gross profit

     90.7        90.7        88.2        85.7        87.1        3.0   

Operating expenses(1)

     (34.4     (30.4     (29.6     (29.3     (29.7     (1.0
                                                

Income from operations

     56.3        60.3        58.6        56.4        57.4        2.0   

Non-operating income and gains(2)

     1.8        2.5        3.4        1.4        1.0        —     

Non-operating expenses and losses(2)

     (0.4     (1.0     (2.3     (0.6     (0.7     —     
                                                

Income before income tax

     57.7        61.8        59.7        57.2        57.7        2.0   

Income tax expense

     (12.8     (13.1     (13.9     (12.7     (9.1     (0.3
                                                

Consolidated net income

     44.9        48.7        45.8        44.5        48.6        1.7   
                                                

Attributable to:

            

Stockholders of the parent

     44.9        48.2        45.0        43.8        47.6        1.6   

Minority interests

     —          0.5        0.8        0.7        1.0        0.1   
                                                
     44.9        48.7        45.8        44.5        48.6        1.7   
                                                

 

2


     Year Ended December 31,  
     2006(1)     2007(1)     2008(1)     2009     2010  
     NT$     NT$     NT$     NT$     NT$     US$  
    

(in billions, except for percentages and per share and

per pro forma ADS data)

 

Earnings per share:

            

Basic

     4.56        4.94        4.64        4.51        4.91        0.17   

Diluted

     —          4.93        4.63        4.50        4.89        0.17   

Earnings per ADS equivalent:

            

Basic

     45.61        49.35        46.42        45.16        49.10        1.68   

Diluted

     —          49.35        46.31        45.01        48.95        1.68   

US GAAP

            

Net revenues

     186.3        200.9        204.4        200.4        203.8        7.0   

Operating costs and expenses(1)

     (130.0     (138.1     (147.1     (141.8     (145.2     5.0   
                                                

Income from operations

     56.3        62.8        57.3        58.6        58.6        2.0   

Non-operating income, net(2)

     1.1        1.5        1.4        0.8        0.6        —     
                                                

Income before income tax

     57.4        64.3        58.7        59.4        59.2        2.0   

Income tax expense

     (15.3     (14.5     (14.5     (13.6     (10.0     (0.3
                                                

Consolidated net income

     42.1        49.8        44.2        45.8        49.2        1.7   
                                                

Attributable to:

            

Stockholders of the parent

     42.1        49.5        43.7        45.1        48.3        1.7   

Noncontrolling interests

     —          0.3        0.5        0.7        0.9        —     
                                                
     42.1        49.8        44.2        45.8        49.2        1.7   
                                                

Earnings per share:

            

Basic

     4.30        5.08        4.52        4.65        4.98        0.17   

Diluted

     —          5.08        4.51        4.64        4.96        0.17   

Earnings per ADS equivalent:

            

Basic

     43.01        50.81        45.19        46.51        49.78        1.71   

Diluted

     —          50.80        45.09        46.36        49.64        1.70   
     As of December 31,  
     2006(1)     2007(1)     2008(1)     2009     2010  
     NT$     NT$     NT$     NT$     NT$     US$  
    

(in billions, except for percentages and per share and

per pro forma ADS data)

 

Balance Sheet Data:

            

ROC GAAP

            

Working capital

     47.8        60.6        48.3        54.8        48.5        1.7   

Long-term investments

     5.7        5.6        8.9        9.1        13.9        0.5   

Properties

     343.5        330.8        323.0        313.0        305.7        10.5   

Goodwill

     0.1        0.2        0.2        0.3        0.3        —     

Total assets

     461.4        469.6        463.6        449.0        454.3        15.6   

Short-term loans

     0.1        —          0.3        0.8        0.1        —     

Short-term bills payable

     —          —          —          —          0.2        —     

Current portion of long-term loans

     0.3        —          —          0.1        0.3        —     

Long-term loans(3)

     —          —          —          0.2        3.1        0.1   

Deferred income

     1.0        1.5        2.1        2.5        2.6        0.1   

Other liabilities

     8.5        11.0        11.8        7.5        7.5        0.3   

Total liabilities

     61.3        71.8        83.9        70.0        85.7        2.9   

Capital stock

     96.7        96.7        97.0        97.0        77.6        2.7   

Cash dividend on common shares

     40.7        34.6        40.7        37.1        39.4        1.4   

Equity attributable to stockholders of the parent

     400.0        395.0        376.6        375.2        364.6        12.5   

Minority interests in subsidiaries

     0.1        2.8        3.1        3.8        4.0        0.1   

US GAAP

            

Total assets

     398.8        406.2        400.7        385.4        390.5        13.4   

Total liabilities

     78.6        85.7        94.8        78.9        94.4        3.2   

Capital stock

     96.7        96.7        97.0        97.0        77.6        2.7   

Equity attributable to stockholders of the parent(5)

     320.1        317.8        302.8        302.8        292.2        10.0   

Noncontrolling interests

     0.1        2.7        3.1        3.7        3.9        0.1   

 

3


     Year Ended December 31,  
     2006(1)     2007(1)     2008(1)     2009     2010  
     NT$     NT$     NT$     NT$     NT$     US$  
    

(in billions, except for percentages and per share and

per pro forma ADS data)

 

Cash Flow Data:

            

ROC GAAP

            

Net cash provided by operating activities

     100.7        89.0        91.9        77.3        84.8        2.9   

Net cash used in investing activities

     (18.8     (38.6     (34.5     (29.5     (17.4     (0.6

Net cash used in financing activities

     (52.9     (44.3     (52.3     (56.5     (47.0     (1.6

Net increase (decrease) in cash and cash equivalents

     28.8        5.6        5.1        (8.0     17.6        0.6   

Other Financial Data:

            

ROC GAAP

            

Gross margin(4)

     49     46     44     43     43     43

Operating margin(5)

     31     31     29     28     28     28

Net margin(6)

     24     24     22     22     24     24

Capital expenditures

     27.7        25.1        30.1        25.5        24.6        0.8   

Depreciation and amortization

     41.0        39.8        38.2        36.3        34.1        1.2   

Cash dividends declared per share

     3.58  (7)      4.26  (7)      3.83  (7)      4.06  (7)      —  (8)      —  (8) 

Stock dividends declared per share

     1.00        2.10        1.00        —          —  (8)      —  (8) 

 

(1) As a result of the adoption of Interpretation 96-052 issued by the Accounting and Research Development Foundation, or ARDF, in the Republic of China, beginning from January 1, 2008, bonuses paid to employees, directors, and supervisors are recognized as an expense rather than an appropriation of earnings, and we accrued NT$1,891 million, NT$1,964 million and NT$2,358 million (US$80.9 million) in 2008, 2009 and 2010, respectively. Some portion of the aforementioned amounts of NT$41 million, NT$39 million and NT$46 million (US$1.6 million) were capitalized as part of property, plant and equipment. Interpretation 96-052 is effective for the financial statements beginning after January 1, 2008, thus we did not retrospectively restate our financial statements for the years of 2006 and 2007.
(2) Includes interest income of NT$804 million, NT$1,453 million, NT$1,916 million, NT$479 million and NT$475 million (US$16.3 million) for the years ended December 31, 2006, 2007, 2008, 2009 and 2010 respectively, and interest expense of NT$6 million, NT$15 million, NT$4 million, NT$15 million and NT$107 million (US$3.7 million) for the years ended December 31, 2006, 2007, 2008, 2009 and 2010 respectively.
(3) Excludes current portion of long-term loans.
(4) Represents gross profits divided by net revenues.
(5) Represents income from operations divided by net revenues.
(6) Represents net income attributed to stockholders of the parent divided by net revenues.
(7) Dividends for 2006, 2007, 2008 and 2009, in U.S. dollars were US$0.11, US$0.13, US$0.12 and US$0.14, respectively. The amounts were calculated using the exchange rates of the subsequent years for convenience translation.
(8) Dividends for 2010 are expected to be declared at our 2011 annual general stockholders’ meeting scheduled for June 2011.

Currency Translations and Exchange Rates

For the convenience of readers, NT dollar amounts used in this annual report for, and as of, the year ended December 31, 2010 have been translated into U.S. dollar amounts using US$1.00=NT$29.14, set forth in the statistical release of the Federal Reserve Board on December 30, 2010. The U.S. dollar translation appears in parentheses next to the relevant NT dollar amount. We make no representation that any New Taiwan dollar amounts or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or New Taiwan dollars, as the case may be, at any particular rate or at all. On April 15, 2011, the exchange rate was NT$29.04 to $1.00.

 

4


The following table sets forth, for each of the periods indicated, the low, average, high and period-end exchange rates, in New Taiwan dollar per U.S. dollar. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this annual report or will use in the preparation of our periodic reports or any other information to be provided to you.

 

Year Ended December 31,

   Average(1)      High      Low      At Period End  

2006

     32.51         33.31         31.28         32.59   

2007

     32.41         33.41         32.26         32.43   

2008

     31.51         33.58         29.99         32.76   

2009

     33.02         35.21         31.95         31.95   

2010

     31.50         32.43         29.14         29.14   

October

     30.82         31.30         30.42         30.60   

November

     30.32         30.52         30.12         30.47   

December

     29.90         30.37         29.14         29.14   

2011 (through April 15)

     29.30         29.98         28.78         29.04   

January

     29.11         29.98         29.36         29.03   

February

     29.28         29.76         28.78         29.74   

March

     29.49         29.63         29.35         29.40   

April (through 15)

     29.07         29.25         28.92         29.04   

 

Source:   Federal Reserve Statistical Release, Board of Governors of the Federal Reserve System.(1) Annual averages are calculated using the average of exchange rates on the last day of each month during the period. Monthly averages are calculated using the average of the daily rates during the relevant period.

B. Capitalization and Indebtedness

Not applicable.

C. Reasons for the Offer and Use of Proceeds

Not applicable.

D. Risk Factors

Our business and operations are subject to various risks, many of which are beyond our control. If any of the risks described below actually occurs, our business, financial condition or results of operations could be seriously harmed.

Risks Relating to Our Company and the Taiwan Telecommunications Industry

Extensive regulation of our industry may limit our flexibility to respond to market conditions and competition, and our business may suffer.

As a telecommunications service provider in Taiwan, we are subject to extensive regulation. See “Item 4. Information on the Company—B. Business Overview—Regulation” for a discussion of the regulatory environment applicable to us. Any changes in the regulatory environment applicable to us may adversely affect our business, financial condition and results of operations.

Currently, our regulator is the National Communications Commission, which was formed on March 1, 2006 in accordance with the National Communications Commission Organization Law, or the NCC Organization Law, which was intended to transfer regulatory authority over the Taiwan telecommunications industry from the Ministry of Transportation and Communications and the Directorate General of Telecommunications to the National Communications Commission.

 

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We have been designated by the government as a dominant provider of fixed communications and mobile services within the meaning of applicable telecommunications regulations, and as a result, we are subject to special additional requirements imposed by the National Communications Commission. For example, the regulation governing the setting and changing of tariffs allows non-dominant telecommunications service providers greater freedom to set and change tariffs within the range set by the government. If we are unable to respond effectively to tariff changes by our competitors, then our competitiveness, market position and profitability will be materially and adversely affected. According to the Fixed Network Regulations, we are still required to submit a report to the National Communications Commission within 20 days after our board of directors approves the entering into, modification or termination of any contracts regarding leasing of all business, outsourcing of operations or joint operations, the transfer of the whole or substantial part of our business or assets; taking over of the whole of the business or assets of any other company which would have significant impact on our operations. The National Communications Commission also amended the Wireless Regulations and the Third Generation Mobile Telecommunications on April 3, 2009 to impose a similar requirement requiring us to submit a report within 20 days after our shareholders approves one of the above matters or our capital reduction. We were subject to the Statute of Chunghwa Telecom Co., Ltd. prior to our privatization. Although we have been privatized, the Legislative Yuan has not yet abolished the Statute of Chunghwa Telecom Co., Ltd., and at this time, the Statute of Chunghwa Telecom Co., Ltd. is still applicable to us. Under the Statute of Chunghwa Telecom Co., Ltd., the Ministry of Transportation and Communications has the authority to regulate aspects of our business. Any such regulation could be burdensome or conflict with regulations of the National Communications Commission or may otherwise adversely affect our business, financial condition and results of operations.

The regulatory framework within which we operate may limit our flexibility to respond to market conditions, competition or changes in our cost structure. In particular, future decreases in tariff rates could immediately and substantially decrease our revenues. In particular, as a Type I service provider under the Republic of China Telecommunications Act, or Telecommunications Act, we are constrained in our ability to raise prices. For instance, the National Communications Commission adopted a three-year price reduction plan from April 2007 to March 2010 and a second round three-year price reduction plan from April 2010 to March 2013, resulting in a number of price reductions in the tariff structures relating to our domestic fixed communications and mobile communications services. See “Item 5. Operating and Financial Review and Prospects—Overview—Tariff Adjustments”. In addition, the National Communications Commission mandated us to offer telephone services for off-shore islands, including Kinmen, Matsu, Penghu at a preferential domestic long distance rate. We had proposed the preferential tariff plan for these areas accordingly, and it had started on April 1, 2011. The National Communications Commission also asked us to submit a proposal by the third quarter of 2011 for combining island-wide telephone services tariffs into one local telephone service tariff. We are still in negotiation with the National Communications Commission about this proposal. However, we cannot guarantee when this combination will occur and that there will not be a material impact on our business operation and revenues if it does occur.

In addition, we operate our businesses with approvals and licenses granted by the government. If these approvals or licenses are revoked or suspended or are not renewed, or if we are unable to obtain any additional licenses that we may need to operate or expand our business in the manner we desire, then our financial condition and results of operations, as well as our prospects, will suffer.

If we are unable to obtain and maintain the licenses to operate our mobile services business, our business prospects and future results of operations would be adversely affected.

There are currently three mobile network operators that offer 2G mobile services in Taiwan. The licenses granted by the ROC government authorities for operating 2G mobile services on the 900MHz and 1800MHz spectrum will expire in June 2017 rather than in 2012 and 2013 as originally scheduled, according to Executive Yuan’s announcement on November 22, 2010. The Executive Yuan also announced that the rights to use the 2G frequency spectrum will be sold at an auction for technology neutral usage in 2015. If we are unable to successfully acquire the rights to use the frequency spectrum that we need for our future business operations, our business prospects and future results of operations may be adversely affected which as a result may lead to a material impact on our business revenues.

 

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Increasing competition resulting from the ongoing liberalization of the Taiwan telecommunications industry or from alternative means of communication may adversely affect our growth and profitability by causing us to lose customers, charge lower tariffs or spend more on marketing.

Mobile service providers in Taiwan have been offering 3G mobile services for several years. We face increased competition from some of these mobile service providers starting during the economic downturn, when they began offering free on-net call packages. We have also faced increasing competition from new entrants in the Taiwan telecommunications market in recent years. In particular, multiple licenses to operate fixed line, mobile, paging and other services have been issued by the Republic of China government since 1996. The National Communications Commission opened applications for VoIP (070) phone numbers in November 2005. As of the end of 2008, three Type I service providers—New Century InfoComm Tech. Co., Ltd., or Sparq, Taiwan Fixed Network and us—and two Type II service providers—Taiwan Infrastructure Technology Company and one of our subsidiaries, Chief Telecom—have obtained VoIP phone numbers. Our subsidiary, Chief Telecom, has been granted 070 VoIP phone numbers from the National Communications Commission and has launched its 070 phone-to-phone VoIP service in April 2009.

We also face increased broadband competition from cable operators. Cable operators have been using low-priced internet access packages to attract new customers in specific areas and buildings in Taiwan. They have also been upgrading their networks to DOCSIS 3.0 in order to provide higher speed internet access. DOCSIS refers to Data Over Cable Service Interface Specification, which is an international telecommunications standard that permits the addition of high-speed data transfer to an existing cable TV system. To counter these developments, we plan to migrate more of our ADSL customers to FTTx services and to provide even higher speed FTTH access. On December 17, 2010, Kbro Co. Ltd., a cable television company, was acquired by Big Rich Media Limited, which is controlled by the same family that controls Taiwan Mobile. We expect this acquisition to increase the competition for our IPTV and broadband businesses, which could make it difficult for us to acquire channels for our IPTV services and result in the deterioration of our broadband market share and revenues.

Many of our competitors are in alliances with leading international telecommunications service providers and have access to financial and other resources or technologies that may not be available to us. Moreover, as the government continues to liberalize the telecommunications market, such as through the issuance of new licenses or establishment of additional networks, our market position and competitiveness could be materially and adversely affected. We cannot guarantee that our measures to address competition will be effective and our business, financial condition and results of operations may be adversely affected by our competition.

Increasing competition may also cause the rate of our customer growth to reverse or decline, bring about further decreases in tariff rates and necessitate increases in our selling and promotional expenses. Any of these developments could adversely affect our business, financial condition and results of operations.

If we fail to maintain a good relationship with our labor union, work stoppages or labor unrest could occur and the quality of our services as well as our reputation could suffer.

In accordance with our articles of incorporation, besides the managers, deputy managers and human resource directors of our various departments and groups, all of our employees are members of our principal labor union, the Chunghwa Telecom Workers Union. Since our incorporation in 1996, we have experienced disputes with our labor union on such issues as employee benefits and retirement benefits in connection with our privatization as well as the right to protest. Despite having taken measures to improve relations, increase cooperation and ensure mutual benefit with our labor union, such as increasing channels of communications by holding periodic labor resource review meetings and guaranteeing a labor union seat on our board of directions, we cannot assure you that we will be able to maintain a good relationship with our labor union. Any deterioration of our relationship with our labor union could result in work stoppages, strikes or threats to take such an action, which could disrupt our business and operations, and materially and adversely affect the quality of our services and harm our reputation.

 

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We may not realize the benefits we expect from our investments, and this may materially and adversely affect our business, financial condition, results of operations and prospects.

We have made significant capital investments in our network infrastructure and information technology systems to provide the services we offer. In 2010, we made capital expenditures for our domestic fixed communications of NT$14.2 billion (US$489.4 million), our mobile communications business of NT$5.3 billion (US$180.5 million), our internet business of NT$1.9 billion (US$64.8 million), our international fixed communications business of NT$1.8 billion (US$61.3 million) and our other businesses of NT$1.4 billion (US$48.7 million). In order to continue to develop our business and offer new and more sophisticated services, we intend to continue to invest in these areas as well as new technologies. The launch of new and commercially viable products and services is important to the success of our business. We expect to incur substantial capital expenditures to further develop our range of services and products. Commercial acceptance by consumers of new and more sophisticated services we offer may not occur at the rate or level expected, and we may not be able to successfully adapt these services to effectively and economically meet our customers’ demand, thus impairing our expected return from our investments.

We cannot assure you that services enabled by new technologies we are implementing, such as HSPA/ HSPA+ mobile technology, will be accepted by the public to the extent required to generate an acceptable rate of return. In addition, we could face the risk of unforeseen complications in the deployment of these new services and technologies, and we cannot assure you that we will not exceed our estimate of the necessary capital expenditure to offer such services. New services and technologies may not be developed and/or deployed according to expected schedules or may not achieve commercial acceptance or be cost effective. The failure of any of our services to achieve commercial acceptance could result in additional capital expenditures or a reduction in profitability to the extent we are required under applicable accounting standards to recognize a charge for impairment of assets. Any such charge could materially and adversely affect our financial condition and results of operations.

We may also from time to time make equity investments in companies, but we cannot assure you of their profitability. We cannot assure you that losses related to our equity investments will not have a material adverse effect on our financial condition or results of operations.

In 2010, we recognized an other-than-temporary impairment loss of NT$59 million (US$2.0 million) for financial assets carried at cost due to adverse changes in market conditions and operating performance that was below expectations. We may be required to record additional impairment charges in future periods, which may have a material adverse effect on our financial condition and future results of operations.

Changes in technology may render our current technologies obsolete or require us to obtain licenses for introducing new services or make substantial capital investments, financing for which may not be available to us on favorable commercial terms or at all.

The Taiwan telecommunications industry has been characterized by rapid increases in the diversity and sophistication of the technologies and services offered. As a result, we expect that we will need to constantly upgrade our telecommunications technologies and services in order to respond to competitive industry conditions and customer requirements. Developments of new technologies have rendered some less advanced technologies unpopular or obsolete. If we fail to develop, or obtain timely access to, new technologies and equipment, or if we fail to obtain the necessary licenses to provide services using these new technologies, we may lose our customers and market share and become less profitable.

In addition, the cost of implementing new technologies, upgrading our networks or expanding capacity could be significant. In particular, we have made and will continue to make substantial capital expenditures in the near future in order for us to effectively respond to technological changes, such as the continued expansion of our High Speed Packet Access, or HSPA, and HSPA+ mobile network. We will also need to make additional capital expenditures relating to the launch of new businesses, such as Next Generation Network, or NGN, projects to migrate our fixed line networks to NGN. In addition, to meet the increasingly robust high-bandwidth requirements of digital convergence services, we will expand construction of fiber optic networks, including passive optical networks, or PONs and optical distribution networks, or ODNs. To the extent these expenditures exceed our cash resources, we will be required to seek additional debt or equity financing. Our ability to obtain additional financing on favorable commercial terms will depend on a number of factors. These factors include our financial condition, results of operations, cash flows and the prevailing market conditions in the Taiwan and international telecommunications industry, the cost of financing and conditions in the financial markets, and the issuance of relevant government and other regulatory approvals. Any inability to obtain funding for our capital expenditures on commercially acceptable terms could jeopardize our expansion plans and materially and adversely affect our business prospects and future results of operations.

 

8


Our ability to deliver services may be disrupted due to a systems failure, shutdown in our networks, earthquakes or other natural disasters.

Taiwan is susceptible to earthquakes and typhoons. However, we do not carry any insurance to cover damages caused by earthquakes, typhoons or other natural disasters or any resulting business interruption. Our services are currently carried through our fixed and mobile communications networks, as well as through our transmission networks consisting of optical fiber cable, microwave, submarine cable and satellite transmission links, which could be vulnerable to damage or interruptions in operations due to natural disasters. For example, in 2010, losses on property, plant and equipment arising from natural disasters such as earthquakes and typhoons were approximately NT$19 million (US$0.7 million) as recorded in non-operating expenses under ROC GAAP. The occurrence of any natural disasters could impact our ability to deliver services and have a negative effect on our results of operations.

If new technologies adopted by us do not perform as expected, or if we are unable to effectively deliver new services based on these technologies in a commercially viable manner, our revenue growth and profitability will decline.

We are always evaluating new growth opportunities in the broader telecommunications industry and are expecting to be transformed into an Information and Communications Technology (ICT) service provider. Some of these opportunities involve new services for which there are no proven markets, and may not develop as expected. Our ability to deploy and deliver these services will depend, in many instances, on new and unproven technologies. These new technologies may not perform as expected or generate an acceptable rate of return. In addition, we may not be able to successfully develop new technologies to effectively and economically deliver these services, or be able to compete successfully in the delivery of telecommunications services based on new technologies. Furthermore, the success of our wireless data services is substantially dependent on the availability of wireless data applications and devices that are being developed by third-party developers. These applications or devices may not be sufficiently developed to support the deployment of our wireless data services. If we are unable to deliver commercially viable services based on the new technologies that we adopt, our financial condition and results of operations may be materially and adversely affected.

We depend on select personnel and could be affected by the loss of their services.

We depend on the continued service of our executive officers and skilled technical and other personnel. Our business could suffer if we lose the services of any of these personnel and cannot adequately replace them. In particular, we are not insured against the loss of any of our personnel. Moreover, we may be required to increase substantially the number of these employees in connection with any expansion, and there is intense competition for experienced personnel in the Taiwan telecommunications industry. We may not be able to retain our present personnel or attract additional qualified personnel as and when needed. In addition, we may need to increase employee compensation levels in order to attract and retain personnel. We cannot assure you that the loss of the services of any of these personnel would not disrupt our business and operations and materially and adversely affect the quality of our services and harm our reputation.

Our largest stockholder may take actions that conflict with our public stockholders’ best interests.

As of March 31, 2011, the Republic of China government, through the Ministry of Transportation and Communications, owned approximately 35.29% of our outstanding common shares. Accordingly, the government, through its control over our board, as all non-independent board members were appointed by the Ministry of Transportation and Communications, may continue to have the ability to control our business, including matters relating to:

 

   

any sale of all or substantially all of our assets;

 

   

the approval of our annual operation and projects budget;

 

   

the composition of our senior management;

 

9


   

the timing and distribution of dividends;

 

   

the election of a majority of our directors and supervisors; and

 

   

our business activities and direction.

We cannot assure you that our largest shareholder will not take actions that impair our ability to conduct our business competitively or conflict with the best interests of our public stockholders.

Actual or perceived health risks related to mobile handsets and base stations could lead to decreased mobile service usage and difficulties in increasing network coverage and could expose us to potential liability.

According to some published reports, the electromagnetic signals from mobile handsets and cellular base stations may pose health risks or interfere with the operation of electronic equipment. Although the findings of those reports are disputed, actual or perceived risks of using mobile communications devices or of cellular base stations could have a material adverse effect on mobile service providers, including us. For example, our customer base could be reduced, our customers may reduce their usage of our mobile services, we could encounter difficulties in obtaining sites for additional cellular base stations required to expand our network coverage or we may be requested to reduce the number of existing cellular base stations. As a result, our mobile services business may generate less revenues and our financial condition and results of operations may be materially and adversely affected. In addition, we could be exposed to potential liability for any health problems caused by mobile handsets and base stations.

We are subject to litigation that could expose us to substantial liabilities.

We are from time to time involved in litigation, arbitration or administrative proceedings in the ordinary course of our business. See “Item 4. Information on the Company—B. Business Overview—Legal Proceedings.” We cannot predict the outcome of these proceedings, and we cannot assure you that if a judgment is rendered against us in any or all of these proceedings, our financial condition and results of operations would not be materially and adversely affected.

Investor confidence in us may be adversely impacted if we or our independent registered public accountants are unable to attest to or express an unqualified opinion on the effectiveness of our internal control over financial reporting.

We are subject to the reporting requirements of the SEC. The SEC, as directed by Section 404 of the U.S. Sarbanes-Oxley Act of 2002, adopted rules requiring U.S. public companies to include a report of management on our internal control over financial reporting in their annual reports that contain an assessment by management of the effectiveness of our internal control over financial reporting. The effectiveness of internal control over financial reporting has been audited by Deloitte & Touche, an independent registered public accounting firm, who has also audited our consolidated financial statements for the year ended December 31, 2010. Deloitte & Touche has issued an attestation report on the effectiveness of our internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). See “Item 15. Controls and Procedures—Attestation Report of the Registered Public Accounting Firm.”

While the management report included in this annual report concluded that our internal control over financial reporting was effective, we cannot assure you that our management will be able to conclude that our internal control over financial reporting is effective in future years. If in future years we fail to maintain effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act, we could suffer a loss of investor confidence in the reliability of our consolidated financial statements, which in turn could negatively impact the trading price of our ADSs, result in lawsuits being filed against us by our stockholders or otherwise harm our reputation.

 

10


Any further economic downturn or decline in the growth of the population in Taiwan may materially and adversely affect our financial condition, results of operations and prospects.

We conduct most of our operations and generate most of our revenues in Taiwan. As a result, any decline in the Taiwan economy or a decline in the growth of the population in Taiwan may materially and adversely affect our financial condition, results of operations and prospects. In recent years, the banking and financial sectors in Taiwan have been seriously harmed by the general economic downturn in Taiwan and the rest of Asia and the world, which has resulted in a depressed property market and an increase in the number of companies filing for corporate reorganization and bankruptcy protection. The global slowdown in technology expenditures has also from time to time adversely affected the Taiwan economy, which is highly dependent on the technology industry. We cannot assure you that economic conditions in Taiwan will continue to improve in the future or that our business and operations will not be materially and adversely affected by deterioration in the Taiwan economy.

We face substantial political risks associated with doing business in Taiwan, particularly due to domestic political events and the tense relationship between the Republic of China and the People’s Republic of China, which could adversely affect our financial condition and results of operations.

Our principal executive offices and substantially all of our assets are located in Taiwan, and substantially all of our revenues are derived from our operations in Taiwan. Accordingly, our business, financial condition and results of operations and the market price of our common shares and the ADSs may be affected by changes in Republic of China governmental policies, taxation, inflation or interest rates and by social instability and diplomatic and social developments in or affecting Taiwan which are outside of our control. Taiwan has a unique international political status. Since 1949, Taiwan and the Chinese mainland have been separately governed. The People’s Republic of China, or PRC, claims that it is the sole government in China and that Taiwan is part of China. Although significant economic and cultural relations have been established during recent years between the Republic of China and the PRC, relations have often been strained. The PRC government has refused to renounce the use of military force to gain control over Taiwan. Furthermore, the PRC government passed an Anti-Secession Law in March 2005, which authorizes non-peaceful means and other necessary measures should Taiwan move to gain independence from the PRC. Past developments in relations between the Republic of China and the PRC have on occasion depressed the market prices of the securities of companies in the Republic of China. Relations between the Republic of China and the PRC and other factors affecting military, political or economic conditions in Taiwan could materially and adversely affect our financial condition and results of operations, as well as the market price and the liquidity of our securities.

Any future outbreak of contagious diseases may materially and adversely affect our business and operations, as well as our financial condition and results of operations.

Any future outbreak of contagious diseases, such as severe acute respiratory syndrome, avian influenza or H1N1 flu, may disrupt our ability to adequately staff our business and may generally disrupt our operations. If any of our employees is suspected of having contracted any contagious disease, we may under certain circumstances be required to quarantine such employees and the affected areas of our premises. As a result, we may have to temporarily suspend part or all of our operations. Furthermore, any future outbreak may restrict the level of economic activity in affected regions, including Taiwan, which may adversely affect our business and prospects. As a result, we cannot assure you that any future outbreak of contagious diseases would not have a material adverse effect on our financial condition and results of operations.

Stockholders may have more difficulty protecting their interests under the laws of the Republic of China than they would under the laws of the United States.

Our corporate affairs are governed by our articles of incorporation, the Telecommunications Act, and by the laws governing corporations incorporated in the Republic of China. In addition, our corporate affairs may remain governed by the Statute of Chunghwa Telecom Co., Ltd. See “—Extensive regulation of our industry may limit our flexibility to respond to market conditions and competition, and our business may suffer.” The rights of stockholders and the responsibilities of management and the members of the board of directors of Taiwan companies are different from those applicable to a corporation incorporated in the United States. For example, controlling or major stockholders of Taiwan companies do not owe fiduciary duties to minority stockholders. As a result, holders of our common shares and ADSs may have more difficulty in protecting their interests in connection with actions taken by our management or members of our board of directors than they would as public stockholders of a United States corporation.

 

11


Risks Relating to Ownership of Our ADSs and Common Shares

The value of your investment may be reduced by future sales of our ADSs or common shares by us, by the Republic of China government or by other stockholders.

The government may continue to sell our common shares. Sales of substantial amounts of ADSs or common shares by the government or any other stockholder in the public market, or the perception that future sales may occur, could depress the prevailing market price of our ADSs and common shares.

The market value of your investment may fluctuate due to the volatility of, and government intervention in, the Taiwan securities market.

Our common shares are traded on the Taiwan Stock Exchange, which has a smaller market capitalization and is more volatile than the securities markets in the United States and many European countries. The market value of our ADSs may fluctuate in response to the fluctuation of the trading price of our common shares on the Taiwan Stock Exchange. The Taiwan Stock Exchange has experienced substantial fluctuations in the prices and trading volumes of listed securities, and there are currently limits on the range of daily price movements. In recent years, the Taiwan Stock Exchange Index reached a peak of 10,202.20 in February 2000 and subsequently fell to a low of 3,446.26 in October 2001. During 2010, the Taiwan Stock Exchange Index peaked at 8972.5 on December 31, 2010, and reached a low of 7071.67 on January 9, 2010. On April 18, 2011, the Taiwan Stock Exchange Index closed at 8,714.48. The Taiwan Stock Exchange has experienced certain problems, including market manipulation, insider trading and payment defaults. The recurrence of these or similar problems could have a material adverse effect on the market price and liquidity of the securities of Taiwan companies, including our ADSs and common shares, in both the domestic and the international markets.

In response to declines and volatility in the securities markets in Taiwan, the Republic of China government formed the National Financial Stabilization Fund to support these markets through open market purchases of shares in Taiwan companies from time to time. The details of the transactions of the National Financial Stabilization Fund have not been made public. In addition, the government’s Labor Insurance Fund and other funds associated with the government have in the past purchased, and may from time to time purchase, shares of Taiwan companies listed on the Taiwan Stock Exchange or other markets. As a result of these activities, the market price of common shares of Taiwan companies may have been and may currently be higher than the prices that would otherwise prevail in the open market. Market intervention by government entities, or the perception that such activity is taking place, may take place or has ceased, may cause sudden movements in the market prices of the securities of Taiwan companies, which may affect the market price and liquidity of our common shares and ADSs.

We may be sanctioned or lose our licenses for violations of limits on foreign ownership of our common shares, and these limits may materially and adversely affect our ability to obtain financing.

The laws of the Republic of China limit foreign ownership of our common shares. Prior to March 1, 2006, the Ministry of Transportation and Communications, as the competent authority under the Telecommunications Act, had the power to prescribe the limits on foreign ownership of our common shares. After the formation of the National Communications Commission on March 1, 2006, the National Communications Commission replaced the Ministry of Transportation and Communications as the competent authority under the Telecommunications Act pursuant to the NCC Organization Law. The National Communications Commission and the Ministry of Transportation and Communications reached an agreement on foreign ownership of Chunghwa Telecom. An announcement issued by the Ministry of Transportation and Communications on December 28, 2007 stipulated that direct holdings by foreign investors in Chunghwa Telecom cannot exceed 49% of our outstanding share capital and the total direct and indirect holdings by foreign investors cannot exceed 55% of our outstanding share capital. As of April 18, 2011, foreign direct holdings of our outstanding share capital is at 26.46%. If we fail to comply with the applicable foreign ownership limitations, our licenses to operate some of our businesses could be revoked. Moreover, we cannot predict the manner in which the National Communications Commission will exercise its authority over us, and the National Communications Commission could decline to raise, or determine to reduce, this foreign ownership limitation.

 

12


If we are deemed to be in violation of our foreign ownership limitations, any consequences arising from such violation may materially and adversely affect us. Moreover, since we are unable to control ownership of our common shares or ADSs representing our common shares, and because we have no ability to stop transfers among stockholders, or force particular stockholders to sell their shares, we may be subject to monetary fine or lose our licenses through no fault of our own. In that event, our business could be disrupted, our reputation could be damaged and the market price of our ADSs and common shares could decline. These limitations may also materially and adversely affect our ability to obtain adequate financing to fund our future capital requirements or to obtain strategic partners, and alternate forms of financing may not be available on terms favorable to us or at all.

Restrictions on the ability to deposit our common shares into our ADS program may adversely affect the liquidity and price of the ADSs.

The ability to deposit shares into our ADS program is restricted by Republic of China law, under which no person or entity, including you and us, may deposit our common shares into our ADS program unless the Securities and Futures Bureau has not objected within a prescribed period following the filing with it of an application to do so, except for the deposit of the common shares into our ADS program and for the issuance of additional ADSs in connection with:

 

   

distribution of share dividends or free distribution of our common shares;

 

   

exercise of preemptive rights of ADS holders applicable to the common shares evidenced by our ADSs in the event of capital increases for cash; or

 

   

purchases of our common shares in the domestic market in Taiwan by the investor directly or through the depositary and delivery of such shares or delivery of our common shares held by such investors to the custodian for deposit into our ADS program, subject to the following conditions: (a) the depositary may accept deposit of those shares and issue the corresponding number of ADSs with regard to such deposits only if the total number of ADSs outstanding after the deposit does not exceed the number of ADSs previously approved by the Securities and Futures Bureau, plus any ADSs issued pursuant to the events described above; and (b) this deposit may only be made to the extent previously issued ADSs have been cancelled.

As a result of the limited ability to deposit common shares into our ADS program, the prevailing market price of our ADSs on the New York Stock Exchange may differ from the prevailing market price of the equivalent number of our common shares on the Taiwan Stock Exchange.

You will be more restricted in your ability to exercise voting rights than the holders of our common shares, which may diminish your influence over our corporate affairs and may reduce the value of your ADSs.

Holders of American depositary receipts evidencing our ADSs may exercise voting rights with respect to the common shares represented by these ADSs only in accordance with the provisions of our deposit agreement. The deposit agreement provides that, upon receipt of notice of any meeting of holders of our common shares, the depositary bank will, as soon as practicable thereafter if requested by us in writing, mail to ADS holders the notice of the meeting sent by us, voting instruction forms and a statement as to the manner in which instructions may be given by the holders.

ADS holders will not generally be able to exercise voting rights attaching to the deposited securities on an individual basis. Under the deposit agreement, the voting rights attaching to the deposited securities must be exercised as to all matters subject to a vote of stockholders collectively in the same manner, except in the case of an election of directors and supervisors. The election of our directors and supervisors is by means of cumulative voting. In the event the depositary does not receive voting instructions from ADS holders in accordance with the deposit agreement, our chairman or his or her designee will be entitled to vote the common shares represented by the ADSs in the manner he or she deems appropriate at his or her discretion, which may not be in your interest.

 

13


Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

We may from time to time distribute rights to our stockholders, including rights to acquire our securities. Under the deposit agreement, the depositary will not offer you those rights unless the distribution to ADS holders of both the rights and any related securities are either registered under the U.S. Securities Act of 1933, as amended, or the Securities Act, or exempt from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.

If the depositary is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or reasonably practicable, it will allow the rights to lapse, in which case you will receive no value for these rights.

Changes in exchange controls that restrict your ability to convert proceeds received from your ownership of ADSs may have an adverse effect on the value of your investment.

Your ability to convert proceeds received from your ownership of ADSs depends on existing and future exchange control regulations of the Republic of China. Under the current laws of the Republic of China, an ADS holder or the depositary, without obtaining further approvals from the Central Bank of the Republic of China (Taiwan) or any other governmental authority or agency of the Republic of China, may convert NT dollars into other currencies, including U.S. dollars, in respect of:

 

   

the proceeds of the sale of common shares represented by ADSs or received as share dividends with respect to the common shares and deposited into the depositary receipt facility; and

 

   

any cash dividends or distributions received from the common shares represented by ADSs.

In addition, the depositary may also convert into NT dollars incoming payments for purchases of common shares for deposit in the depositary receipt facility against the creation of additional ADSs. If you withdraw the common shares underlying your ADSs and become a holder of our common shares, you may convert into NT dollars subscription payments for rights offerings. The depositary may be required to obtain foreign exchange approval from the Central Bank of the Republic of China (Taiwan) on a payment-by-payment basis for conversion from NT dollars into foreign currencies of the proceeds from the sale of subscription rights of new common shares. Although it is expected that the Central Bank of the Republic of China (Taiwan) will grant approval as a routine matter, required approvals may not be obtained in a timely manner, or at all.

Under the Republic of China Foreign Exchange Control Law, the Executive Yuan of the Republic of China may, without prior notice but subject to subsequent legislative approval rendered within ten days from such imposition, impose foreign exchange controls or other restrictions in the event of, among other things, a material change in domestic or international economic conditions which might threaten the stability of the domestic economy in Taiwan.

You are required to register with the Taiwan Stock Exchange and appoint several local agents in Taiwan if you withdraw common shares from our ADS facility and become our stockholder, which may make your ownership burdensome.

If you are a non-Republic of China person and wish to withdraw common shares represented by your ADSs from our ADS facility and hold those common shares, you are required under the current laws and regulations of the Republic of China to appoint an agent, also referred to as a tax guarantor, in the Republic of China for filing tax returns and making tax payment. A tax guarantor must meet certain qualifications set by the Ministry of Finance of the Republic of China and, upon appointment, becomes a guarantor of your Republic of China tax obligations. If you wish to repatriate profits derived from the sale of withdrawn common shares or cash dividends or interest on funds derived from the withdrawn common shares, you will be required to submit evidence of your appointment of a tax guarantor and the approval of the appointment by the Republic of China tax authorities. You may not be able to appoint and obtain approval for a tax guarantor in a timely manner.

 

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In addition, under the current laws of the Republic of China, you will be required to be registered as a foreign investor with the Taiwan Stock Exchange for making investments in the Republic of China securities market prior to your withdrawal and holding of common shares represented by the ADSs. You will be required to appoint a local agent in Taiwan to, among other things, open a securities trading account with a local securities brokerage firm and a bank account to remit funds, exercise stockholders’ rights and perform other functions as holders of ADSs may designate. You must also appoint a local bank to act as custodian for handling confirmation and settlement of trades, safekeeping of securities and cash proceeds and reporting and declaration of information. Without the relevant registration and appointment of the local agent and custodian and the opening of a securities trading account and bank account, you will not be able to hold, subsequently sell or otherwise transfer our common shares withdrawn from the ADSs facilities on the Taiwan Stock Exchange.

Our actual financial results may differ materially from our published yearly guidance.

Before 2009, we voluntarily published operating results guidance for the current fiscal year prepared in accordance with R.O.C. GAAP. In 2009 and 2010, we published operating results guidance on a quarterly basis. Beginning in 2011, we reverted to publishing our operating results guidance on an annual basis again and no longer publish operating results guidance on a quarterly basis. These projections are based on a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies, including the risks factors described in this annual report. In particular, projections are forward-looking statements that are necessarily speculative in nature, and it can be expected that one or more of the estimates on which the projections were based will not materialize or will vary significantly from actual results, and such variances will likely increase over time.

 

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

Our legal and commercial name is Chunghwa Telecom Co., Ltd. We were officially established on July 1, 1996 as part of the Republic of China government privatization efforts. Prior to our formation, we were operating as a business unit of the Directorate General of Telecommunications. The common shares of the Company have been listed on the Taiwan Stock Exchange under the number “2412” since October 2000 and its ADSs have been listed on the New York Stock Exchange under the symbol “CHT” since July 2003. In August 2005, we became a privatized company as the ownership of the Taiwan government was reduced to less than 50%. Today, we are the largest full telecommunication service provider in Taiwan. Our principal executive offices are located at 21-3 Hsinyi Road, Section 1, Taipei, Taiwan, Republic of China, and our telephone number is (886) 2-2344-5488. Our website address is http://www.cht.com.tw. The information on our website does not form a part of this annual report.

We are the largest telecommunications service provider in Taiwan and one of the largest in Asia in terms of revenues. As an integrated telecommunications service provider, our principal services include:

 

   

domestic fixed communications services, including local and domestic long distance telephone services, broadband access services, local and domestic long distance leased line services, multimedia on demand, or MOD, services, domestic data services and domestic other services;

 

   

mobile communications services, including mobile and paging services, sales of mobile handsets and data cards and mobile other services;

 

   

internet services, including HiNet, our internet service provider, internet value-added services, data communication services, internet data center services, and internet other services

 

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international fixed communications services, including international long distance telephone services, international leased line services, international data services, satellite services and international other services; and

 

   

other services, including non-telecom services.

In addition to these traditional telecommunication services, we also focus on selected Information and Communication Technology (ICT) service and advanced development, such as cloud computing.

For each of our key services, we enjoy leading positions across a number of areas:

 

   

we are Taiwan’s largest provider of domestic fixed communications services in terms of both revenues and customers;

 

   

we are Taiwan’s largest mobile communications service provider in terms of both revenues and customers;

 

   

we are Taiwan’s largest broadband internet access provider as well as Taiwan’s largest internet service provider in terms of both revenues and customers; and

 

   

we are also a leading player in the data communications market in Taiwan.

In 2010, our revenues under R.O.C. GAAP were NT$202.4 billion (US$6.9 billion), our consolidated net income was NT$48.6 billion (US$1.7 billion) and our basic earnings per share was NT$4.91 (US$0.17).

In 2010, we made capital expenditures totaling NT$24.6 billion (US$0.8 billion), of which 58% was related to our domestic fixed communications business, 21% was related to our mobile communications business, 8% was related to our internet business, 7% was related to our international fixed communications business and 6% was related to our other businesses. See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures” for a discussion of our capital expenditures.

Competitive Strengths

We believe that we are well positioned to take advantage of growth opportunities in the telecommunications market in Taiwan as new technologies evolve. In particular, we have maintained our leading market share in mobile communications and internet services since the opening of the Taiwan telecommunications market to competition in June 2001. Furthermore, we have enjoyed greater flexibility in making purchasing and other business decisions after we were privatized in August 2005.

We believe that further deregulation and market liberalization will continue to drive the growth of the overall market for telecommunications services in Taiwan, as well as the development of new products and services. We expect to benefit from additional opportunities as the telecommunications market in Taiwan continues to grow.

We believe that our primary competitive strengths are:

 

   

our broad customer base in Taiwan;

 

   

our position as an integrated, full-service telecommunications provider in Taiwan; and

 

   

our capital resources and technology, which we believe we can build on to expand our leading position in the mobile communications and internet services markets, including through our continued construction of our existing 3G/HSPA/HSPA+ mobile network, our expansion of FTTx broadband access services, IP-based MOD services, fixed/mobile value added and cloud computing related services, and our future construction of a fourth generation long term evolution mobile network if we win the technology neutral license in 2015.

 

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We have a broad customer base in Taiwan.

We are the largest telecommunications service provider in Taiwan with a broad customer base across all of our service offerings. Despite deregulation and an increase in competition in the Taiwanese telecommunications industry, we have maintained a market leading position in our primary service offerings of fixed communications, mobile communications and internet services. We believe our broad customer base in each of our service offerings grants us a distinct competitive advantage to maintain our existing customers and attract new customers and increases the chance of success for the launch and popularization of new products. As the telecommunications industry continues its trend of converging fixed communications, mobile communications and internet services, we believe that our comprehensive service offerings places us in a strong position to offer converged products and services to our customers.

We are an integrated full-service telecommunications provider in Taiwan.

We are the largest telecommunications service provider in Taiwan with a leading position in fixed communications services, mobile communications services and internet services.

Broad range of communications products and services. We believe that our ability to provide an attractive and comprehensive range of telecommunications services positions us to provide bundled and value-added services to our business and residential customers. In addition, we are able to offer innovative integrated services and tariff packages to meet the specific needs of our customers.

Broad network coverage. The breadth of our network and our ownership of the so called “last mile” infrastructure in Taiwan, which comprises the connection between the local telephone service provider’s switching centers to the end-users’ buildings or homes, provide us with access to existing and potential customers and creates a platform for expanding our services. As of December 31, 2010, substantially all of our installed telephone lines were capable of delivering ADSL services and network coverage of ADSL was approximately 97%. In order to provide higher bandwidth services for our customers, we are constructing our FTTx network. As of December 31, 2010, network coverage of FTTx with speed of 30Mbps was approximately 79.3%. In addition, our mobile communications network provides nationwide coverage. Our large cellular spectrum allocation together with our network of 16,215 base stations position us well for the continued expansion of our mobile services in Taiwan.

Brand awareness, distribution channels and customer service. Our principal brands “Chunghwa Telecom” and “HiNet” have a reputation for quality, reliability and sophisticated technology. In particular, we are the leading internet service provider in Taiwan through HiNet. We serve our large and well-established customer base through our extensive customer service network in Taiwan, including 23 operations offices, 313 service centers, 221 exclusive service stores and six customer service centers. We also offer comprehensive and high-quality point of sale and after sale services, and we provide web-based customer services. Moreover, our extensive sales and distribution channels help us attract additional customers and develop new business opportunities. In 2010, we obtained several domestic and international awards which recognized our service quality, corporate governance and corporate social responsibility. In the Reader’s Digest Trusted Brands Award, we have stood out and won the Platinum Award of Telecom Company in Taiwan for seven consecutive years since 2004. We were awarded “Best Managed Company,” “Best Corporate Governance, “Best Corporate Social Responsibility” and “Best Commitment to Strong Dividends” in Taiwan by FinanceAsia. We were also awarded the “Excellence in Corporate Social Responsibility Award” by the Common Wealth Magazine, “Excellent Service Award 2010” by Global Views, “Best Corporate Governance and Disclosure” in the Greater China Awards 2010 by IR Magazine, and “Excellence for Financial Disclosure Procedures” in Asia Pacific by IR Global Rankings.

Operational expertise. Our management and employees have extensive operating experience and technical knowledge, which we believe cannot be easily replicated by competitors. We also believe we will continue to attract and retain high quality employees.

Comprehensive customer billing infrastructure. As Taiwan’s leading telecommunications services provider, we have extensive resources and infrastructure relating to billing services. In particular, we issue, in the aggregate, approximately 17 million invoices, including integrated bills, every month. We intend to continue taking advantage of this unique attribute by offering bill collection services to internet content providers and other entities that lack the necessary resources and infrastructure for effective customer billing.

 

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We have the capital resources and technology to enhance our leading position in the growing mobile communications and internet services markets.

Enhancing position in our leading markets. Revenues from our mobile communications and internet services have increased from 55.4% of revenues in 2008 to 56.1% in 2010. We expect our mobile communications, internet, broadband value-added and information and communication technologies services to continue to be the key drivers of our future growth. With our leading market share, we enjoy substantial economies of scale in equipment procurement as well as the marketing of our products and services.

Strong capital structure. We believe we have greater financial resources than other telecommunications operators in Taiwan. In particular, our relatively low debt-to-equity capital structure, together with our high levels of cash and operating cash flows, provides us with the flexibility and resources to invest in capital intensive and growing businesses. In particular, we continue to invest in broadband internet protocol networks, fiber-optic networks, and 3G mobile communications networks and services. We also have begun making investments in or acquiring other companies which provide complementary telecommunications and internet-related services to further expand our business and offer new products and services.

Advanced network technology. Since 2003, we have developed and upgraded our existing infrastructure for both mobile and fixed line networks. We developed a high-speed internet protocol backbone network, expanded the coverage of our ADSL network and deployed a 3G network. In 2008, we launched a long-term next generation network construction project that will upgrade our local fixed line networks to high-speed packet-based digital networks with FTTx technologies, including FTTC/N, FTTB and FTTH, in order to provide high speed internet, VoIP, MOD and high definition television, or HDTV, services. We have also upgraded our 3G network to HSPA and HSPA+. In 2011, we will expand HSPA/HSPA+ coverage to provide better mobile internet services with speeds of up to 21 Mbps. Our investment in network infrastructure places us in a position to capture a significant share of the internet and high-speed data transmission market.

Research and development expertise. As of March 31, 2011, we employ over 2,128 research professionals and engineers whose principal focus is to develop advanced network services and operations support systems and to build selected core technologies. In 2010, our research and development expenses accounted for 1.6% of our revenues under R.O.C. GAAP. We believe our focus on research and development will allow us to efficiently develop and deploy new technologies and services ahead of our competitors.

Business Strategy

Taiwan has one of the highest fixed line penetration rates in Asia and has also experienced rapid adoption of wireless communications and internet services, including broadband access services. We believe that telecommunications services will evolve over the coming years, driven by a number of technological innovations, including cloud computing and mobile broadband and Internet of Things. We also believe that the convergence of communications technologies will provide a significant competitive advantage to integrated telecommunications service providers that are able to design and construct sophisticated and scalable networks capable of serving as a common platform for a broad range of services.

Our key strategic objectives are to maintain our position as a leading integrated telecommunications services provider in Taiwan and to enhance our leadership position in growing markets, such as the mobile services and internet services markets, including fixed/mobile broadband access services and value-added services.

 

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Consistent with our strategic objectives, we have developed the following business strategies:

Focus on our core strengths while expanding our scope of services to capture new growth opportunities

Our core strengths are the management of telecommunication networks and the provision of services over these networks. We currently operate several networks linked by a core backbone infrastructure consisting of public switched telephone, cellular, ADSL, FTTx and internet protocol networks. Our strategy for each network differs depending on the market dynamics and future growth prospects of services delivered over these networks. In general, we endeavor to maintain our strong market position in each of our business lines and seek to expand the scope of our business beyond network services by offering value-added services to generate growth and new opportunities.

Fixed communications: Our strategy is to maintain our position as the market leader in domestic fixed communications. In addition to our Public Switched Telephone Network, or PSTN, customer retention program, we are working on NGN projects to facilitate network migration into IP Multimedia Subsystem, or IMS. The first stage of our IMS network was completed in March 2009. This is the largest ever NGN deployment that has been constructed in Taiwan, with more than 500,000 subscriber facilities. To enhance business efficiency and reduce operational expenditures, we constructed a new Multi-Protocol Label Switching-, or MPLS-, based IP backbone to consolidate existing IP networks in September 2008. Based on these facilities, we will collaborate with the third parties to develop new integrated services to retain our customers and generate new revenue streams. For provision of new services, we launched our multimedia value-added services in October 2010. These services include provision of home-based surveillance cameras and daily life information, entertainment and phone services.

Broadband services: We also plan to continue to build on the success of our broadband access services.

 

   

We provided ADSL and FTTx services to 4.4 million customers, which represented more than 80.5% of Taiwan’s fixed line broadband customers by the end of 2010. We have successfully migrated many of our customers from low-speed to higher-speed internet access services and upgraded ADSL subscribers to FTTx, which offers an even higher speeds by using fiber optic technology. Approximately 84% of our broadband customers subscribe for downlink speeds of over 2 Mbps, and 46.7% were with FTTx as of December 31, 2010.

 

   

We are continuing the build-out of our FTTx infrastructure. Because we typically realize higher average revenue per user for our FTTx internet services, we plan to continue offering various incentives for our ADSL and other internet customers to switch to our FTTx services. In 2010, FTTx revenue has reached 58.3% of our total broadband revenue.

Mobile Communications: We offer our mobile services via both 2G and 3G networks. For 2G, we are using standard of Global System for Mobile Communications or GSM while for 3G, wideband code division multiple access, or WCDMA is adopted. In order to meet the demand from our customers for high-speed wireless data access, we upgraded our 3G mobile service to High-Speed Packet Access, or HSPA technology on September 12, 2006 and to HSPA+ services in 2010, and are continuing to develop next generation mobile technologies. Our strategy for mobile service includes the following initiatives:

 

   

Focusing on maintaining our average revenue per user by promoting increased use of wireless value-added services, such as our “emome” service, Hami services, Java games, ring-back tone services, video streaming, e-books, and online shopping.

 

   

Encouraging our customers to use our 3G and HSPA/HSPA+ services by offering customized mobile handsets combined with attractive value-added services and product packages;

 

   

Expanding our HSPA+ coverage and enhancing the data rate up to 21 Mbps to attract more mobile internet customers; and

 

   

Catering for the high bandwidth usage of smart phone and Tablet PCs, we have constructed more than 10,000 Wi-Fi Hotspot in 2010 to share some of the data traffic from the mobile network. We will continue to expand another 10,000 hotspots using Wi-Fi solutions in 2011.

 

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Converging fixed communications and mobile communications services to provide customers with access to personalized information through personal computers or mobile handsets;

 

   

Taking advantage of our superior brand and network quality to attract our competitors’ customers;

Internet services: Our strategy for internet services is to continue to build on the success of our HiNet internet services and enhance our internet value-added services.

 

   

We are developing new media to provide both higher-speed access as well as attractive content to our customers. We are also continually enhancing our internet value-added services, such as online games, internet music, internet banking and internet protocol video services, including hiChannel, an internet platform where customers can view videos and multimedia content.

 

   

We have installed hiCloud CaaS servers and are planning to construct a cloud computing center for the provision of internet data center and cloud computing services.

Integrated services: We believe integrated services are effective in encouraging usage and enhancing customer loyalty. We intend to increase our offerings for integrated services. In particular, we believe we are positioned to provide our customers with fully integrated solutions across fixed communications, mobile communications and internet platforms. Our “Friends and Family” service, which offers customers preferential rates, has attracted over 1.54 million mobile customers. In addition, we provide a wide range of integrated services customized to meet the needs of our corporate customers, such as integrated network management services, integrated information and communication services, secure internet services, enterprise push mail services, 3G mobile office and mPro business service, which is designed for business professionals who need to access information, such as their email, calendar, contacts and news, wirelessly. We are also developing cloud-based multi-screen services in relation to music, media, news information and payment. We started to offer HiCloud CaaS (Compute as a Service), StaaS (Storage as a Service) in 2010 and we plan to provide customers SoD (Service on Demand) which allows flexibility for customers to make their own choices of HiCloud services.

Emphasize quality of service and customer satisfaction

Quality of service is critical in attracting and retaining customers and enhancing our long-term profitability. In order to continually enhance and improve the quality of our services, we have, in addition to the quality assurance function of our regular operating units, established a number of dedicated task forces to monitor our network performance. Our senior management sets our quality evaluation criteria and regularly reviews the quality of our performance.

In order to ensure that our quality of service will translate into strong customer loyalty, we plan to continue to focus on and invest in the provision of a full range of services that emphasize customer care from the point of sale onward. For example, we have extended the focus of our corporate customer services from major accounts to include small and medium-sized enterprises and in January 2007 established our Enterprise Business Group. As of December 31, 2010, our Enterprise Business Group is staffed by approximately 344 professionals and offers packaged and customized services, customer-oriented solutions and integrated information and communications services. We have completed the integration of our call centers, all of which can now be reached by calling a single number “123.” We offer 24-hour customer service, including the handling of service and billing inquiries with the assistance of an Interactive Voice Response, or IVR, system. To improve the quality of our customer services, we implemented a customer relationship management system, which encompass, among other things, a customer complaint system, a business information database for the use of our call centers, and a data mining system to enhance our sales and market analysis efforts.

Improve operational efficiency and cost structure

We have historically been focused, and will continue to focus, on cost control, particularly in the areas of network efficiencies and personnel costs. We expect to be able to further improve our operational efficiency and cost structure by migrating to more advanced networks and sophisticated operational support systems, and efficiently managing our workforce.

 

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Capital expenditures. Our long-term goal is to optimize our capital expenditures by focusing on investing in innovative products and services with attractive return profiles. We have commenced a project for gradually upgrading our entire public switched telephone network to a next-generation network. Next-generation internet protocol switches will have substantially more capacity and greater upgrade flexibility and should result in savings from a reduced number of switching centers and a reduction in related property, materials and personnel costs. We have also devoted resources toward the expansion of our 3G mobile network and the continuing build-out of our FTTx infrastructure.

Personnel costs. We seek to improve our operational efficiency by reducing our personnel costs. For example, we offered voluntary retirement programs once each year since 2005, which resulted in reductions of 5,329 employees. We also hired more than 2,966 new employees after our privatization in August 2005. Since then, we continued to align our organizational structure by integrating various operating units and departments. We will also continue to reallocate our personnel from traditional fixed line services to our growing businesses and to our marketing and customer services departments, as well as exploring outsourcing opportunities where we deem appropriate.

Expand our business through alliances, acquisitions and investments

We plan to expand our business in high-growth areas, such as interactive multimedia broadband services, content delivery services and value-added services, through alliances, acquisitions and investments. We believe that our experience, operational scale and large customer base make us an attractive ally for other service providers.

Alliances. We have formed and will continue to pursue alliances with information content providers, multimedia service platform providers, customer premises equipment providers, internet portal operators, information and communication technology solutions partners to diversify our business operations and enhance our service offerings. As of the date of this annual report, we have collaborated with more than 440 information content providers, more than 180 customer premises equipment providers, more than 10 internet service providers, more than one internet portal operator and more than 50 information and communication technology solution partners. In 2010, we signed MOUs with some international companies such as Trend Micro, Intel Corporation, Quanta Computer, Sky Cloud Technology and Inventec Corporation to cooperate on ICT and cloud computing businesses. We believe that our experience in running Internet data centers and our ability to serve retail customers coupled with the technologies offered by these partners will position us advantageously in this new area. In February 2011, we signed an MOU with HTC to form a strategic partnership to work on customized handsets and share marketing resources.

Acquisitions and Investments. We have focused our acquisition strategy on making acquisitions of companies that we believe to be complementary to our long-term strategic goals. In addition, after our privatization, we have focused our investment strategy on the development of new businesses and the enhancement of our operation efficiency. We have entered into the following notable transactions:

In January 2007, we acquired a 31.3% ownership in SENAO International Co., Ltd., or Senao, one of the largest mobile handset distributors in Taiwan with a significant market share in Taiwan. Our investment in Senao has increased our competitiveness in the mobile services business, strengthened our sales of mobile handsets and logistics management and benefited our financial condition. Because SENAO offers warrants to employees, our shareholding in SENAO was diluted to 28.4% by the end of 2010 due to the exercise of options.

In January 2008, we acquired a 16.67% ownership interest in Industrial Bank of Taiwan II Venture Capital Co., Ltd. to expand our overseas network of investment companies and increase investment opportunities in emerging markets. Also in January 2008, we became a 33.4% stockholder of Kingwaytek Technology Co., Ltd., whose core businesses are the production and sales of electronic maps, technical assistance with computer peripherals and creation and development of specialized system applications. By combining our resources, we seek to build a high-quality geographic information system, or GIS, database and to develop applications related to GIS, location-based services, telematics and intelligent transportation systems to further revenue growth from our GIS-related services.

 

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In January 2008, we established a wholly owned subsidiary named Light Era Development Co., Ltd., a company that engages in the real estate development business. The management team of Light Era Development Co., Ltd. has extensive experience in real estate development. Their experience will provide support for our strategy of redeveloping our real estate holdings. We plan to focus on managing rental revenues from our existing properties and several new properties that will begin leasing in the near future.

In April 2008, we acquired a 33.33% ownership interest in Viettel-CHT IDC, or Viettel, an internet database center provider in Vietnam. In acquiring and developing a working relationship with Viettel, we seek to strengthen our overseas network, further our global expansion strategy and capture the growth opportunities in the Vietnamese economy and telecommunications industry. Our equity stake in Viettel was reduced slightly from 33.33% to 30% in September 2009 because of our relatively lower capital injection in Viettel’s second round of capital increase compared with the first round.

To further our expansion into the international telecommunications market overseas, we established two wholly owned subsidiaries, Chunghwa Telecom Singapore Pte., Ltd. and Chunghwa Telecom Japan Co., Ltd., in July and September 2008, respectively. The core businesses of these subsidiaries include data wholesale, IP transiting services, international private leased circuit, or IPLC, IP VPN and voice wholesale. Both companies have successfully obtained all the necessary and relevant local telecommunication licenses and permits to operate. Through these subsidiaries, we hope to strengthen our overseas sales channels, generate sales from Taiwanese and other multinational corporations, increase international incoming voice traffic and IP transiting services and increase our overseas revenues.

In September 2008, to reinforce our satellite capabilities by replacing the ST-1 telecommunications satellite, we established ST-2 Satellite Ventures Pte., Ltd. in Singapore with our partner SingTelSat Pte., Ltd. Our ownership in ST-2 Satellite Ventures Pte., Ltd. is 38% and we have invested NT$409.1 million in this entity through to the end of 2010.

In January 2009, we became a 49% stockholder in InfoExplorer Co., Ltd., a company whose core businesses include IT solution provision, IT application consultation, system integration and package solution. The combination of InfoExplorer’s IT expertise with our communication technology capabilities will boost our information and communication technology profile. The stockholders of InfoExplorer Co., Ltd., at the special meeting of stockholders held on February 25, 2011, approved the merger with International Integrated System Inc. and e-ToYou International, Inc. in accordance with the Business Mergers and Acquisitions Act. Upon the merger on April 1, 2011, InfoExplorer Co., Ltd. became the surviving company and International Integrated System, Inc. and e-ToYou International, Inc. were dissolved. The name of the surviving company is “International Integrated System, Inc.” and our shareholding is 33.47%.

In April 2009, we acquired a 30% equity interest in So-net Entertainment Taiwan Limited, or So-net, the fourth largest ISP in Taiwan. We acquired the equity interest in So-net to transform So-net into one of our sub-brands in order to compete against other cable internet service providers.

In September 2009, we increased our stake in Chunghwa Investment from 49% to 89% and became the parent company of Chunghwa Investment.

In June and July 2010, we acquired a 3.31% and 3.36% equity interest in Innovation Works Limited respectively. In June 2010, we invested 13.3% in Innovation Works Development Fund, which was established to support the development of Innovation Works Limited. We believe our investment in Innovation Works Limited, which mainly invests in mobile internet industry in mainland China, will help open up our business opportunities in e-commerce, mobile internet and cloud computing services in the mainland.

 

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In June 2010, we became a 18.2% stockholder of CQi Energy Infocom Inc. (CQi), which engages mainly in intelligent energy network management services.

In September 2010, we established Chunghwa Precision Test Tech. USA Corporation (CHPT(US)), that engages in the testing service of semi-conductor components and printed circuit boards.

In March 2011, we established a wholly owned subsidiary Chunghwa Telecom (China) Co., Ltd., which engages mainly in selling computer software, network equipment and communication materials, and providing installation, design and maintenance services.

Going forward, we may consider making other equity investments and acquisitions that we believe are complementary to our business and strategic goals. Our future investment will be aimed at expanding our business scale and scope, making better use of our research and development resources and operational experience and increasing our revenues through investing in core telecom businesses as well as value-added services. We expect to target the markets of our overseas investments from Southeast Asia to China while carefully evaluating the risks involved.

Maintain focus on maximizing stockholder value

We are committed to maximizing stockholder value and intend to maintain our high dividend payout policy. Following our privatization, we have more flexibility to implement capital management initiatives, including possible repurchases of our outstanding common shares and increases in our leverage through debt financing. We bought back 192,000,000 shares between February 10, 2006 and April 7, 2006 and cancelled those shares on June 30, 2006. We bought back 121,075,000 shares between August 29, 2007 and October 25, 2007 and cancelled those shares on December 29, 2007 and February 21, 2008, respectively.

In 2007, we effected a capital reduction plan by a transfer of capital surplus in the amount of NT$9.7 billion to capital stock. Subsequently, capital stock was reduced by NT$9.7 billion and a liability for the actual amount of cash to be distributed to stockholders of NT$9.6 billion was recorded. The difference between the reduction in capital stock and the distribution amount represents treasury stock of NT$0.1 billion, which was concurrently cancelled. Such cash payment to stockholders was made on January 9, 2008. We effected an additional capital reduction plan in 2008 by transferring NT$19.1 billion from capital surplus to capital stock and the same amount was later reduced from capital stock. The cash payment of NT$19.1 billion was made on March 20, 2009 to our stockholders. We effected an additional capital reduction plan in 2009 by transferring capital surplus in the amount of NT$9.7 billion to capital stock and the same amount was later reduced from capital stock. The cash payment of NT$9.7 billion was made on February 8, 2010 to our stockholders. We effected an additional capital reduction plan in 2010 by reducing 20% capital stock in the amount of NT$19.4 billion. The cash payment of NT$19.4 billion was made on January 25, 2011 to our stockholders.

B. Business Overview

Our Principal Lines of Business

Our core business segments are our domestic fixed communications business, mobile communications business, internet business and international fixed communications business.

Domestic Fixed Communications Business

The provision of domestic fixed communications services is one of our principal business activities. Our domestic fixed communications business includes local and domestic long distance telephone services, broadband access services, local and domestic long distance leased line services, multimedia on demand services, and domestic other services. We are the largest provider of local and domestic long distance telephone services in Taiwan. We also provide interconnection with our fixed line network to other mobile and fixed line operators. Since June 2001, three new operators have begun offering fixed line services. Our revenues from domestic fixed communications services were NT$73.1 billion, or 36.2% of our revenues, in 2008, NT$71.5 billion or 36.0% of our revenues in 2009 and NT$70.7 billion (US$2.4 billion), or 34.9% of our revenues in 2010. Owing primarily to the expansion of our mobile communications services and the general trend of a continued decline in fixed line voice traffic, we expect that revenues from our domestic fixed communications business as a percentage of our total revenues will continue to decline.

 

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Local Telephone

The following table sets forth our revenues from local telephone services for the periods indicated.

 

     Year ended December 31,  
     2008      2009      2010  
     NT$      NT$      NT$      US$  
            (in billions)             (in millions)  

Local telephone revenues:

           

Usage

     11.5         10.6         10.0         341.9   

Subscription

     17.7         17.2         17.0         584.4   

Interconnection

     2.5         2.5         2.4         81.7   

Pay telephone

     0.7         0.6         0.5         17.9   

Other

     2.2         2.3         2.9         99.0   
                                   

Total

     34.6         33.2         32.3         1,107.0   
                                   

We provide local telephone services to approximately 12.31 million customers in Taiwan. Our fixed line network reaches virtually all homes and businesses in Taiwan. Revenues from local telephone services comprised 17.1%. 16.7% and 15.9% of our total revenues in 2008, 2009 and 2010, respectively. Approximately 74.5% of our local telephone customers as of December 31, 2010 were residential customers, accounting for 59.5% of our local telephone revenues in 2010. We are currently the leader of the local telephone service market, with an average market share of approximately 97.3%, 97.1% and 96.9% in 2008, 2009 and 2010, respectively.

The following table sets forth information with respect to our local telephone customers and penetration rates as of the dates indicated.

 

     As of December 31,  
     2008     2009     2010  
    

(in thousands, except percentages

and per household data)

 

Taiwan population (1)

     23,037        23,120        23,162   

Fixed line customers:

      

Residential

     9,530        9,328        9,165   

Business

     3,203        3,120        3,142   

Total

     12,733        12,448        12,307   

Growth rate (compared to the same period in the prior year)

     (1.7 )%      (2.2 )%      (1.1 )% 

Penetration rate (as a percentage of the population)

     55.3     53.8     53.1

Lines in service per household

     1.24        1.19        1.15   

 

(1) Data from the Department of Population, Ministry of the Interior, Republic of China.

Demand for local customer lines has historically been driven by population growth. However, with the development of mobile technologies, this trend has been declining. The number of fixed line customers decreased by 2.2% in 2009 compared to 2008 due to customers replacing fixed lines with mobile services and also as a result of the adverse economic conditions. The number of fixed line customers decreased by 1.1% in 2010 compared to 2009. We attribute the decrease in fixed line customers to a general industry-wide trend of migrating from fixed line services to mobile and Internet telephony services.

 

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The following table sets forth information with respect to local telephone usage for the periods indicated.

 

     Year ended December 31,  
     2008     2009     2010  
     (in millions, except percentages)  

Minutes from local calls(1)(2)

     15,877        14,602        13,671   

Growth rate (compared to the same period in the prior year)

     (8.1 )%      (8.0 )%      (6.4 )% 

 

(1) Includes minutes from local calls made on pay telephones.
(2) Calls to our HiNet internet service, which are recorded as part of our internet services, are not included in our local call minutes or revenues.

Minutes from local calls declined due to traffic migration to mobile services as well as VoIP services. However, we believe the rate of migration of traffic from fixed communication services to VoIP and mobile communications services is slowing.

We charge our local telephone service customers a monthly fee and a usage fee. We also charge separate fees for some value-added services. The monthly fees for our primary tariff plans are NT$70 with a deductible on usage fees of NT$25 for residential customers and NT$295 for business customers. Our primary peak time usage fee is NT$1.6 for three minutes or NT$2.7 for ten minutes, depending on the tariff plan selected by the customer, and our off-peak usage fee is NT$1.0 for ten minutes. Our usage fees are the same for residential and business customers.

The following table sets forth information with respect to the average local telephone usage charge per minute for the periods indicated.

 

     Year ended December 31,  
     2008     2009     2010  
     NT$     NT$     NT$  

Average local telephone usage fee (per minute)

     0.74        0.74        0.74   

Growth rate (compared to the same period in the prior year)

     1.4     0.4     0.5

Average per minute usage charges remained flat at around NT$0.74 per minute in 2008, 2009 and 2010. Part of our competitive strategy is to offer customers innovative products and services intended to both secure customer loyalty and enhance revenues. In particular, our value-added services are designed to increase our call revenues by increasing the number of calls our customers make and by receiving fees for usage of the value-added services. These services include call waiting, caller identification, call forwarding, three-party calls, ring back tone and voicemail.

Domestic Long Distance Telephone

We provide domestic long distance telephone services in Taiwan. Total revenues from domestic long distance telephone services comprised 4.2%, 3.7% and 3.3% of our revenues in 2008, 2009 and 2010, respectively. Our average market share in the domestic long distance market was approximately 85.2%, 82.9% and 76.1% in 2008, 2009 and 2010, respectively. Residential customers accounted for 59.2% of our domestic long distance revenues in 2010.

The following table sets forth information with respect to usage of our domestic long distance telephone services for the periods indicated.

 

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     Year ended December 31,  
     2008     2009     2010  
     (in millions, except percentages)  

Domestic long distance telephone service usage (minutes)

     4,000        3,649        3,415   

Growth rate (compared to the same period in the prior year)

     (7.5 )%      (8.8 )%      (6.4 )% 

Minutes of use for domestic long distance calls have been declining as a result of traffic migration to mobile services, competition from other fixed line operators and increased use of VoIP. We expect declines in minutes of use for fixed line services to continue in the future for the same reasons.

The following table sets forth information with respect to the average domestic long distance telephone usage charge per minute for the periods indicated.

 

     Year ended December 31,  
     2008     2009     2010  

Average domestic long distance telephone usage fee (per minute)

   NT$ 1.68      NT$ 1.68      NT$ 1.61   

Growth rate (compared to the same period in the prior year)

     1.2     0.3     (4.2 )% 

All domestic long distance calls, regardless of the distance between the calling parties, have the same tariff. We changed the unit of billing from a per-minute basis to a per-second basis effective February 1, 1999. In addition, we reduced our peak hour domestic long distance rate in April 2001 from NT$0.045 per second to our current rate of NT$0.033 per second. Our current domestic long distance rate for off-peak hours is NT$0.0235 per second. The rates for both peak hours and off-peak hours are the same for residential and business customers. Our average domestic long distance usage charge per minute increased 0.3% in 2009 due to a 0.15% increase in the unit price of long distance direct dial services and a 11.7% increase in the unit price of domestic long distance calls from public phones over 2009. The unit price of domestic long distance calls decreased by 4.2% from 2009 to 2010 because of the resolution of mandatory tariff reduction passed by the National Communications Commission.

We provide so-called “intelligent” network services over our domestic long distance network, including toll-free calling, universal number, televoting, premium rate service and VPNs. We also focus on offering our customers an increasing number of value-added services and flexible tariff packages.

Broadband (ADSL+ and FTTx) Access

We provide broadband internet access through connections based on ADSL and our FTTx technology. FTTx generally offers a faster access medium for our internet customers compared to ADSL by using fiber optic technology. We are continuing the build-out of our FTTx infrastructure. The majority of our FTTx deployments consist of fiber-to-the-node with some fiber-to-the-building deployments. The majority of the local loops still use copper wires, and we do not have any present plans to upgrade the local loops to fiber optic lines. Because we typically realize higher average revenue per user for our FTTx internet services, we are offering various incentives for our ADSL and other internet customers to switch to our FTTx services.

We provide ADSL access services to other internet service providers that do not have their own network infrastructure, and as a result, our ADSL customers also include some customers that use us only for the ADSL data access line and choose another provider for ISP services. We began providing our ADSL service in August 1999 and had approximately 2.3 million customers as of December 31, 2010. Our ADSL service allows for transmission of data at high access rates and offers high-speed broadband internet access services. As of December 31, 2010, approximately 75.9%, or 1.8 million, of our ADSL customers were also our HiNet subscribers. As a result of increased migration to our higher-bandwidth FTTx services, the number of our ADSL customers declined in 2010.

The following table sets forth our revenues from our broadband access services for the periods indicated.

 

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     Year ended December 31,  
     2008      2009      2010  
     NT$      NT$      NT$  
     (in billions)  

Broadband access revenues:

        

Broadband access (ADSL and FTTx)

     20.0         19.9         20.3   

We provide FTTx internet services, with downlink speeds of 10, 20, 50 and 100 Mbps, in 2010. The number of our FTTx customers increased significantly in 2008, 2009 and 2010 as prices became more affordable, coverage areas expanded and customer demand for higher bandwidth heightened. Many of new FTTx customers have migrated from using our HiNet dial-up and ADSL internet services. Of the approximately 2.04 million FTTx customers as of December 31, 2010, approximately 84.8% were those that migrated from our ADSL services. We also provide FTTx access services to other internet service providers that do not have their own network infrastructure, and as a result, our FTTx customers also include some customers that only use us for the FTTx data access line and choose another ISP to provide internet services. Of the approximately 2.04 million FTTx customers as of December 31, 2010, approximately 1.8 million were also our HiNet subscribers. We currently offer various promotional packages to encourage more migration of our HiNet dial-up and ADSL subscribers to our FTTx service. As of December 31, 2010, 44.4% of HiNet subscribers accessed the internet through our FTTx service, and we expect this ratio to increase in the future as a result of these promotional measures.

Our market share of Taiwan’s broadband market was approximately 83.8%, 83.0% and 80.5% in 2008, 2009 and 2010, respectively.

The following table sets forth our broadband service customers as of each of the dates indicated.

 

     As of December 31,  
     2008      2009      2010  

ADSL service customers (in thousands)

     3,241         2,666         2,329   

FTTx service customers (in thousands)

     1,070         1,638         2,045   

Average downlink speed (Mbps)

     4.33         5.1         6.1   

Our ADSL service offers downlink speeds that range from 256 kilobits per second to 8 Mbps and uplink speeds that range from 64 kilobits per second to 640 Kbps. In December 2001, we began providing symmetrical digital service with uplink and downlink speeds of 512 kilobits per second. After our promotions in 2004 to increase customer access speeds, including our promotions for customers to upgrade to higher-speed access, the average uplink and downlink speeds of our customers have increased substantially. In 2010, we offered ADSL low speed customers a free upgrade to high speed ADSL service. As of December 31, 2010, approximately 84% of our customers had subscribed for downlink speeds of over 2 Mbps, and our average downlink speed was 6.1 Mbps. Our FTTx service offers downlink speeds of 10, 20, 50 and 100 Mbps matched with uplink speeds of 2, 2, 3 and 5 Mbps, respectively.

We have experienced competition in the ADSL and FTTx service market from other fixed line operators and cable operators. Our strategy is to continue the migration of ADSL subscribers to FTTx so as to increase the average revenue per user. In addition, in order to strengthen customer loyalty, we have provided free speed upgrades for ADSL customers who were using lower speed services since August 2010. Due to the aforementioned initiatives, we were able to maintain the number of our broadband subscribers.

Our revenues from providing internet access are generated from installation fees, monthly subscription fees and usage fees from fixed line telephone calls made by dial-up customers to access HiNet, which are recorded as domestic data services revenues rather than as local revenues. Usage fees from fixed line telephone calls made to access internet service providers other than HiNet are recorded as local revenues.

 

27


Charges for our HiNet dial-up service include a monthly fee entitling the customer to a fixed number of minutes of service, with an additional charge per minute when the fixed number of minutes is exceeded. Alternatively, we offer our customers an unlimited number of minutes for a fixed monthly fee. Charges for our ADSL and FTTx services include one-time installation charges and monthly subscription fees. These charges for our ADSL and FTTX services vary based on connection speed.

The following table sets forth our average revenue per user for each of the periods indicated.

 

     Year ended December 31,  
     2008      2009      2010  
     NT$      NT$      NT$  

Average revenue per user for HiNet dial-up services per month(1)

     33         24         17   

Average revenue per user for ADSL services per month(2)

     701         638         598   

Average revenue per user for FTTx services per month(3)

     1,085         1,022         1,019   

 

(1) Average revenue per user for HiNet dial-up services per month is calculated by dividing the sum of local telephone usage revenues generated by HiNet dial-up subscribers and internet access revenues by the average of the number of our HiNet dial-up subscribers on the first and last days of the period and dividing the result by the number of months in the relevant period.
(2) Average revenue per user for ADSL service services per month is calculated as the sum of (a) ADSL access revenues for the relevant period divided by the average of the number of our ADSL customers on the first and last days of the period divided by the number of months in the relevant period and (b) HiNet ADSL service revenues divided by the average of the number of HiNet ADSL subscribers on the first and last days of the period divided by the number of months in the relevant period.
(3) Average revenue per user for FTTx service services per month is calculated as the sum of (a) FTTx access revenues for the relevant period divided by the average of the number of our FTTx service customers on the first and last days of the period divided by the number of months in the relevant period and (b) HiNet FTTx internet service provider revenues divided by the average of the number of HiNet FTTx subscribers on the first and last days of the period divided by the number of months in the relevant period.

The decline of our ADSL average revenue per user over the last three years was due to the National Communications Commission mandated tariff reduction and the decline of FTTx average revenue per user was due to the promotional packages and discounts provided for existing customers. However, we expect our average revenue per user for broadband services to remain stable going forward as many customers will continue to migrate towards more expensive and higher speed FTTx services which will offset the declining average revenue per user of ADSL and FTTx themselves. For more details of the National Communications Commission mandated tariff reduction, please see “Item 5. Operating and Financial Review and Prospects—Overview—Tariff Adjustments”.

Leased Line Services—Local and Domestic Long Distance

We are the leading provider of domestic leased line services in Taiwan. Leased line services involve offering exclusive lines that allow point-to-point connection for voice and data traffic. Leased lines are used by business customers to assemble their own private networks and by telecommunications service providers to establish networks to offer telecommunications services.

We provide data transmission services to major corporate customers in Taiwan. We also provide leased lines to other mobile and fixed line service operators for interconnection with our fixed line network and for connection within their networks.

The following table shows the bandwidth of local and domestic long distance lines leased to third parties as of each of the dates indicated.

 

28


     As of December 31,  
     2008      2009      2010  
     (in gigabits per second, or Gbps)  

Total bandwidth

     790.0         1,069.4         1,486.4   

Rental fees for local leased lines are generally based on transmission speed while domestic long distance leased line rental fees are generally based on transmission speed and distance.

We continue to experience a decline in rental fees for all of our leased line products. The decline in rental fees since 2000 has been substantial partly as a result of broadband services substitution and other service providers constructing their own lines. In response, we continue to implement marketing and service campaigns to retain our high-value corporate customers.

We launched our wireless local area network service in May 2002. As of December 31, 2010, we had a total of approximately 63,577 residential and business customers that lease our access points. In addition, we have established 10,146 hot spots in public areas, such as convenience stores, airports and international convention centers, where individuals can access our wireless local area network.

Multimedia on Demand Services

We launched our multimedia-on-demand, or MOD, service in Taipei County and Keelung City in March 2004. As of December 31, 2010, we have expanded this service to all 18 counties and cities of Taiwan. Using video streaming technology through a set top box that connects to our FTTx and ADSL data connections, our customers can access TV programs and other services. We had over 126 broadcasting channels and over 8,000 hours worth of on-demand programs and served approximately 0.8 million customers as of December 31, 2010. In addition, our video-on-demand service provides movies, dramas, animations, documentaries, e-learning and music programs for home entertainment. Also, we currently offer 16 high definition, or HD, channels and other HD video-on-demand programming, such as sports, movies and knowledge materials. We offered “family package” channels in 2010 to enhance our service content and satisfy our customers’ needs. MOD revenues accounted for NT$0.6 billion, NT$0.9 billion and NT$1.1 billion (US$37.5 million) in 2008, 2009 and 2010, respectively.

Domestic Other Services

Our domestic other services include information and communication technology services, corporate solution and bill handling services.

Mobile Communications Business

Mobile communications services are one of our principal business activities. Our mobile communications services include mobile and paging services, sales of mobile handsets and data cards and mobile other services.

Mobile Services

We are Taiwan’s largest provider of mobile services in terms of both revenues and customers. In 2008, we generated revenues of NT$72.4 billion, or 35.9% of our total revenues, from mobile services. In 2009, we generated revenues of NT$71.4 billion, or 35.9% of our total revenues, from mobile services. In 2010, we generated revenues of NT$73.1 billion (US$2.5 billion), or 36.1% of our total revenues, from mobile services.

 

     Year ended December 31,  
     2008      2009      2010  
     NT$      NT$      NT$      US$  
            (in billions)             (in millions)  

Mobile services revenues:

           

Usage (1)

     56.4         54.4         53.0         1,820.1   

Interconnection

     7.2         7.0         7.2         248.2   

 

29


     Year ended December 31,  
     2008      2009      2010  
     NT$      NT$      NT$      US$  
            (in billions)             (in millions)  

Mobile data

     7.0         8.4         11.1         379.3   

Other

     1.8         1.6         1.8         59.5   
                                   

Total mobile services

     72.4         71.4         73.1         2,507.1   
                                   

 

(1) Includes monthly fees.

As the market for mobile services has continued to expand, we have experienced substantial growth in our mobile customer base. We are the largest mobile operator in Taiwan in terms of revenues and number of customers. We had 9.68 million mobile customers, for a market share of approximately 34.8% of total mobile customers and approximately 34.2% of total mobile services revenues in Taiwan, as of December 31, 2010.

We offer digital mobile service through our dual band GSM network. We are one of the three national licensed providers of GSM services. We have been allocated 15 MHz in the 900 MHz frequency band and 11.25 MHz in the 1800 MHz frequency band for GSM services and general packet-switched radio services, or GPRS, and 15 MHz paired spectrum plus 5 MHz unpaired spectrum in the 2 GHz frequency band for 3G mobile services. This is the largest frequency spectrum allocation to any mobile operator in Taiwan. In February 2002, the Ministry of Transportation and Communications granted 3G mobile services concessions to five companies, including us. In March 2002, we paid NT$10.2 billion to the government for our concession. Our 3G mobile services license is valid until December 31, 2018. In July 2005, we launched our 3G mobile services using WCDMA technology. We also offer the largest international roaming network among Taiwan mobile service providers. In particular, our 2G customers have access to 338 networks in 179 countries through our GSM service roaming network and 227 networks in 113 countries through our GPRS roaming network. In addition, our 3G service system includes 101 networks in 52 countries.

As of December 31, 2010, we had approximately 16,215 cellular base stations (including both GSM base stations and 3G cellular base stations) covering substantially all of Taiwan’s population. We use these base stations to support both our GSM network and 3G networks. In 2010, we upgraded more than 6,756 3G cellular base stations with HSDPA capacity and 2,455 GSM base stations with EDGE capacity in the larger metropolises of Taiwan. We will continue this process of implementing HSDPA and EDGE upgrades in the major areas of Taiwan.

The following table sets forth information regarding our mobile service operations and our mobile customer base for the periods indicated.

 

     As of or for the year ended December 31,  
     2008     2009     2010  

Taiwan population (in thousands)(1)

     23,037        23,120        23,162   

Total mobile customers in Taiwan (in thousands)(2)

     25,413        26,959        27,840   

Penetration (as a percentage of the population)(2)

     110.3     116.6     120.2

Total mobile revenues in Taiwan (in billions)(3)

   NT$ 215.9      NT$ 215.2      NT$ 213.2   

Number of our mobile customers (in thousands)(2)(4)

     8,947        9,269        9,679   

Our market share by customers(2)

     35.2     34.4     34.8

Our market share by revenues

     33.5     33.1     34.2

Number of our prepaid customers (in thousands)(4)

     728        839        945   

Our prepaid customers as a percentage of our total customers

     8.1     9.0     9.8

Annualized churn rate(5)

     11.81     11.21     10.35

Minutes of usage (in millions of minutes)

      

Incoming

     10,442        10,500        11,063   

Outgoing

     9,595        9,702        10,190   

Average minutes of usage per user per month(2)(6)

     189        185        187   

Average revenue per user per month(2)(7)(8)

   NT$ 684      NT$ 653      NT$ 643   

 

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(1) Data from the Department of Population, Ministry of the Interior, Republic of China
(2) The number of mobile customers is based on the number of subscriber identification module, or SIM, cards. Since 2006, the total number of mobile customers in Taiwan included personal handy-phone system, PHS and 3G customers.
(3) Data from the statistical monthly release by the National Communications Commission in the Republic of China, which include mobile revenues 2G, 3G and PHS.
(4) Includes GSM, GPRS and 3G services.
(5) Measures the rate of customer disconnections from mobile service, determined by dividing (a) our aggregate voluntary and involuntary deactivations (excluding deactivations due to customers switching from one of our mobile services to another) during the relevant period by (b) the average number of customers during the period (calculated by averaging the number of customers at the beginning of the period and the end of the period), and multiplying the result by the fraction where (c) the numerator is 12 and (d) the denominator is the number of months in that period.
(6) Average minutes of usage per user per month is calculated by dividing the total minutes of usage during the period by the average of the number of our mobile customers on the first and last days of the period and dividing the result by the number of months in the relevant period.
(7) Average revenue per user per month is calculated by dividing our aggregate mobile services revenues during the relevant period by the average of the number of our mobile customers on the first and last days of the period and dividing the result by the number of months in the relevant period.
(8) Due to reclassification of our business segments in 2009, non-core value-added service revenues are now included under mobile services. Revenues for 2008 have been recalculated to reflect the new classifications.

Total mobile customers in Taiwan have reached approximately 28 million as of December 31, 2010. Mobile penetration was approximately 120.2% on the same date. The overall mobile services market experienced a slight decrease of 1% in revenues in 2010 due to the mandatory tariff reduction imposed by the National Communications Commission.

We began offering prepaid card services in October 2000 and prepaid 3G card services in February 2008. As of December 31, 2010, we had approximately 0.9 million prepaid customers representing approximately 9.8% of our total mobile customers. Prepaid customers do not pay monthly fees but pay a higher usage charge on a per second basis. Once the prepayment has been fully utilized, a prepaid customer can make additional prepayments to continue the service. Alternatively, the customer may convert to become a post-paid customer while retaining the same telephone number.

We offer incentives, such as mobile handset subsidies, when new customers agree to sign a service contract with us or when existing customers renew their contracts with us ranging from 18 months to 30 months. We generally offer subsidies on mobile handsets equipped with more advanced data functions to promote the expansion of our GPRS and 3G mobile services. Smartphones accounted for 25% of the total handsets we offered in 2010, and we expect that the percentage to reach more than 35% in 2011. Since smartphones typically have higher handset subsidies, we expect our average subsidy per handset to increase slightly in 2011.

While pricing has declined, the number of post-paid customers has increased which had a positive impact on traffic volume. We have also experienced a significant increase in the mobile internet service. The average minutes of usage per customer slightly declined in both 2008 and 2009 due to the deteriorating macroeconomic conditions in Taiwan. Since the economy in Taiwan started to improve in 2010, both the customer demand and the minutes of usage have increased.

Our tariffs for post-paid mobile customers primarily consist of usage fees and monthly fees. When our customers are outside Taiwan, they pay roaming charges plus international long distance charges and, where applicable, local charges in roaming destinations. We negotiated with Vodafone, the largest telecommunications service provider in Europe, in November 2009 to join their global telecommunications alliance. As a result, we began offering our customers discounts on their roaming charges starting December 1, 2009. We charge a flat fee per transaction for our short messaging service and a fee per packet for our GPRS based on the volume of data transmitted. We also offer discounts on usage fees for calls made between our mobile customers to encourage subscription to our mobile service. Our 3G service also provides a monthly flat rate service to our customers using our 3G service for internet purposes.

 

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Our average revenue per user per month decreased from NT$653 in 2009 to NT$643 in 2010 due to increased price competition with our competitors. The decline in average revenue per user in 2010 compared to the previous two years has slowed down due to the strong promotion of our mobile internet services which leads to the rapid growth in value added service revenues and helps to cover for the decline in the voice call revenues. In order to continue to reduce the decline in average revenue per user, we intend to continue introducing new value-added services and promote our 3G and 3.5G and wireless internet services.

In addition to our basic mobile services, we also offer a broad range of value-added telecommunications and information services. In August 2001, we introduced a platform of integrated mobile value added services under the brand name “emome.” Our “emome” services offer a broad range of value-added services, including financial information, transaction services, emergency services access numbers, directory information, time, weather and traffic reports. In addition, we launched other mobile value-added services, such as JAVA games, unstructured supplementary service data, mobile internet and multimedia messaging services. After the launch of our 3G mobile services, we began providing video phone, video-on-demand and other related 3G mobile value-added services as well. In 2009, we successfully created a business model integrating smart phones with customer-tailored services, promoted our mobile internet service business, created the “Hami” value-added service platform and led the industry in providing e-book service and Hami Apps service. In addition to creating additional sources of revenues, we believe these services enhance customer loyalty and satisfaction and increase mobile traffic. Revenues from mobile data services represented 9.7%, 11.8% and 15.1% of our total mobile services revenues in 2008, 2009 and 2010, respectively.

Paging Services

Due to substitution by mobile services and a decline in demand for our paging services in recent years, beginning in February 2007, we started downsizing our paging services by limiting access to certain telephone prefixes. We are planning to discontinue our paging services in the near future.

Sales of Mobile Handsets and Data Cards

We engage in the distribution and sales of mobile handsets for use on our mobile network to customers through our directly-owned stores and also through third-party retailers. In January 2007, we acquired 31.33% equity ownership of Senao, a major distributor of mobile handsets in Taiwan, and obtained majority board representation in April 2007, upon which it became a consolidated subsidiary of ours. The addition of Senao significantly enhanced our mobile handset distribution and sales capabilities. Beginning in April 2007, we started accounting for the revenues from our subsidiary, Senao, under our mobile handset business.

We began sales of HSPA data cards in 2006 for high-speed mobile internet access service for notebook users. Currently, the maximum internet access speed for our HSPA data cards is 14.4 Mbps/5.76Mbps downlink speed/uplink speed. We are planning to provide higher speed HSPA+ internet access data cards in the future.

Other Mobile Services

Our mobile other services include information and communication technology services, corporate solution and bill handling services.

Internet Business

We have experienced continued growth in our internet services. Our internet business includes HiNet, our internet service provider, internet value-added services, or VAS, data communication services, internet data center services, and internet other services. Our internet revenues represented 11.4%, 11.9% and 12.1% of our revenues in 2008, 2009 and 2010, respectively.

 

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HiNet Internet Service

We are the largest internet service provider, or ISP, in Taiwan, with a market share of 69.6% as of December 31, 2010. As of December 31, 2009 and 2010, HiNet had approximately 4.1 million subscribers. The increase of our HiNet broadband subscribers was offset by the decrease of HiNet dial-up subscribers. Our HiNet internet service generated revenues of NT$17.7 billion, NT$17.3 billion and NT$18.2 billion (US$0.6 billion) in 2008, 2009 and 2010, respectively.

The following table sets forth HiNet’s subscribers as of each of the dates indicated.

 

     As of December 31,  
     2008     2009     2010  
    

(in thousands, except

percentages)

 

Total internet subscribers in Taiwan

     6,027        5,668        5,888   

HiNet subscribers:

      

HiNet dial-up subscribers

     580        534        507   

HiNet ADSL subscribers

     2,498        2,043        1,768   

HiNet FTTx subscribers

     1,016        1,486        1,818   

Other access technology subscribers

     9        4        3   
                        

Total HiNet subscribers

     4,103        4,067        4,096   
                        

Market share(1)

     68.1     71.8     69.6

 

(1) Based on data provided by the National Communications Commission.

We have maintained our leading market position despite a highly competitive market with over 181 internet service providers in Taiwan. We expect the competitive conditions currently prevailing in the internet service provider market to continue to intensify.

Internet Value-added Services

Our HiNet portal at www.hinet.net provides value-added services to our customers, such as network security, Blog, travel, games, e-learning, financial information, music, video, anti-virus and links to other portals. We charge fees for some of these services. We also receive commissions for transactions completed on some of these other portals. Our internet video portal at www.hichannel.hinet.net offers online entertainment services through the internet. In particular, our HiNet broadband (ADSL and FTTx) subscribers can access music, television programs, movies and other multi-media content on demand. We charge access fees for some of this content. We expect the revenues generated from these value-added services to grow as a percentage of our total internet services revenues.

Data Communication Services and Internet Data Center Services

We provide a wide range of managed data services, including frame relay services, asynchronous transfer mode services, and VPN services. Frame relay services provide high-speed data communications linking remote sites. Asynchronous transfer mode services are used to handle high-bandwidth, integrated voice, video, data and internet traffic between sites.

Internet data centers are facilities providing the physical environment necessary to keep computer network servers running at all times. These facilities are custom-designed with high-volume air conditioning temperature control systems, secure access, reliable electricity supply and connections to high-bandwidth internet networks. Data centers house, protect and maintain network server computers that store and deliver internet and other network content, such as web pages, applications and data. We currently have the greatest number of internet data centers in Taiwan compared to our competitors in Taiwan. We offer co-location, web hosting and application service provider services. To expand our internet data center services and strengthen our cooperation with international telecommunications operators, we acquired a 70% equity interest of Chief Telecom in September 2006, which increased our internet data center market share to over 45% as of the end of 2010. We offered customers hicloud CaaS (Compute as a Service) and StaaS (Storage as a Service) in 2010 to enhance working efficiency and optimize the utilization of resources. We also continue to construct our cloud computing center.

 

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Internet Other Services

Our internet other services include government services, corporate solution and information and communications technology, or ICT, services.

International Fixed Communications Business

Our international fixed communications business include international long distance telephone services, international leased line services, international data services, satellite services and international other services.

International Long Distance Telephone

We provide international long distance telephone services in Taiwan. Total revenues from international long distance telephone services comprised 7.0%, 6.5% and 6.4% of our revenues in 2008, 2009 and 2010, respectively. Residential customers generated 35.5% of our international long distance revenues during 2010. In addition, we provide wholesale international long distance services to international simple resale operators that do not possess their own telephone network or infrastructure.

Since international fixed communication services have been open for competition since 2001, we expect competition in this line of business will continue to intensify. We believe other fixed communication operators consider the international long distance market to be their primary focus. Our average market share of the international long distance market was approximately 59.5%, 60.3% and 58.4% in 2008, 2009 and 2010, respectively. Our market share decreased in 2010 primarily because of the intense competition in the international telecommunications business. Our international long distance services consist primarily of international direct dial services and our discounted “Super eCall” services, which we introduced in April 2000. Under Super eCall, we use VoIP technology through international dedicated circuits which connect to our major correspondent carriers that route calls internationally. Super eCall customers are offered rates that are approximately 30% lower than those for our international direct dial service. Calls made over Super eCall represented 4.7% and 4.1% of our total outgoing international traffic in 2009 and 2010, respectively. The proportion of Super eCall traffic is relatively lower because despite the fact that the international direct dial business is declining, the various kinds of strategic promotions we continue to make have helped to slow down the decline.

We commenced the wholesale of international long distance minutes to licensed international resale operators and other international carriers in 2001. International resale operators require a fixed line operator in Taiwan to complete their long distance telephone services originating in Taiwan. In addition, other international carriers often find it less expensive to route international calls through Taiwan. These resale operators and carriers purchase from us large numbers of minutes at discounted rates. Our international long distance wholesale business has grown rapidly since its introduction. In 2008, 2009 and 2010, we sold 1,158.9 million, 1,291.6 million and 1,360.0 million of wholesale outgoing minutes, which represented approximately 48.8%, 51.1% and 50.1% of our total outgoing international long distance minutes, respectively. Revenues from the wholesale of international long distance minutes increased by 11.8% from NT$2,536 million in 2009 to NT$2,836 million in 2010. As the international long distance market becomes more competitive, we believe the wholesale business will allow us to generate increases in international minutes without accelerating the decrease in international long distance rates in the more profitable retail segment.

International calls to our top five destinations represented 71.9% of our outgoing international long distance call traffic in 2010. International calls from our top five destinations represented 49.0% of our incoming international long distance call traffic in 2010.

 

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The following table shows the percentage of total outgoing international long distance minutes for our top five outgoing destinations in 2010.

 

Destination

   Percentage of  total
outgoing minutes
 

Mainland China

     38.9

Indonesia

     11.8   

Philippines

     8.1   

Vietnam

     7.7   

United States

     5.4   
        

Total of top five destinations

     71.9
        

The following table shows the percentage of total incoming international long distance minutes for our top five incoming destinations in 2010.

 

Destination

   Percentage of total
incoming minutes
 

Mainland China

     20.7

United States

     10.8   

Japan

     7.7   

Malaysia

     5.4   

Indonesia

     4.3   
        

Total of top five destinations

     49.0
        

The following table sets forth information with respect to usage of our international long distance services for the periods indicated.

 

     As of December 31,  
     2008     2009     2010  
    

(in thousands, except percentages

and incoming/outgoing ratio)

 

Incoming minutes

     1,948        1,865        1,915   

Growth rate (compared to the same period in the prior year)

     16.9     (4.3 )%      2.7

Outgoing minutes

     2,375        2,527        2,715   

Growth rate (compared to the same period in the prior year)

     (0.6 )%      6.4     7.4

Total minutes

     4,323        4,392        4,630   

Incoming/outgoing ratio

     0.82        0.74        0.71   

Total outgoing international long distance minutes increased 6.4% from 2008 to 2009 primarily due to increases in our international long distance wholesale and transit businesses. Our outgoing call volume increased by 7.4% from 2009 to 2010 primarily because we actively develop the market for foreign labor and as a result, the traffic for international pre-paid services increased by 24.4% in 2010 leading also to the overall growth in the international traffic. Our incoming call volume decreased by 4.3% from 2008 to 2009 primarily due to decreased traffic as a result of deteriorating economic conditions and our incoming call volume increased by 2.7% from 2009 and 2010 primarily due to the general recovery of the economy in the ROC.

Outgoing calls made by customers in Taiwan and by customers from foreign destinations using Taiwan direct service are billed in accordance with our international long distance rate schedule for the destination called. Rates vary depending on the time of day at which a call is placed. Customers are billed on a per minute basis for Super eCall services, whereas customers are billed on a six second unit basis for international direct dial services.

 

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The following table sets forth information with respect to the average international long distance usage charge per minute that we received for outgoing international calls during the periods indicated:

 

     Year ended December 31,  
     2008     2009     2010  

Average international long distance usage charge (per minute)

   NT$ 4.2      NT$ 3.6      NT$ 3.4   

Growth rate (compared to the same period in the prior year)

     (6.7 )%      (15.0 )%      (3.9 )% 

Tariffs for international long distance calls have generally been declining worldwide and we expect this trend to continue. We offered our customers significant promotional packages and discounts during off-peak hours in 2008, 2009 and 2010 to maintain their loyalty. In particular, we increased the discounts offered to our high-usage international long distance customers in each of these three years. However, we anticipate that an increase in the international call traffic may partially offset the decline in tariffs.

We pay for the use of networks of carriers in foreign destinations for outgoing international calls and receive payments from foreign carriers for the use of our network for incoming international calls. Traditionally, these payments have been made pursuant to settlement arrangements under the general auspices of the International Telecommunications Union. Settlement payments are generally denominated in U.S. dollars and are made on a net basis.

The following table sets forth information with respect to our gross international settlement receipts and payments during the periods indicated.

 

     Year ended December 31,  
     2008      2009      2010      2010  
     NT$      NT$      NT$      US$  
            (in billions)             (in millions)  

Gross international settlement receipts

     3.7         3.5         3.2         109.1   

Gross international settlement payments

     4.1         4.3         4.2         143.9   

Our payments on an aggregate basis to international carriers have been more than our receipts from these carriers primarily because our customers’ outgoing minutes exceeded incoming minutes.

In order to compete more effectively in the international long distance market, we have implemented innovative and customized discount calling plans and marketing campaigns directed at high-usage business customers. We also continue to promote our intelligent network services, including international VPNs, international toll free calling and calling card services, and our international long distance minutes wholesale business. Our subsidiary, Chief Telecom, launched its 070 phone-to-phone VoIP service in April 2009. When demand for 070 VoIP service grows, we will bundle Chief Telecom’s 070 VoIP service with other services we provide to meet customers’ needs. We currently do not have any plans to launch 070 VoIP service because the National Communications Commission has not given us the right to set the tariffs for outbound calls from 070 numbers.

Leased Line Services—International

We are a leading provider of international leased line services in Taiwan. Leased line services involve offering exclusive lines that allow point-to-point connection for voice and data traffic. Leased lines are used by business customers to assemble their own private networks and by telecommunications service providers to establish networks to offer telecommunications services.

We provide data transmission services to major corporate customers in Taiwan. Since August 2001, licenses have been awarded to four undersea cable operators to engage in leased line services. Demand for high-speed data transmission services has been growing rapidly, as a result of growing consumer demand and lower tariffs due to increased competition. In particular, the total bandwidth of our lines leased increased by 79.8% in 2010.

The following table shows the bandwidth of international lines leased to third parties as of each of the dates indicated.

 

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     As of December 31,  
     2008      2009      2010  
     (in gigabits per second, or Gbps)  

Total bandwidth

     43.3         63.1         113.4   

Rental fees for international long distance leased line rental fees are generally based on transmission speed and distance.

We continue to experience a decline in rental fees for all of our leased line products. The decline in rental fees since 2000 has been substantial, particularly for international leased lines, partly as a result of competition from new international leased line service providers. In response, we continue to implement marketing and service campaigns to retain our high-value corporate customers.

International Data Services

Our international data services include international IP VPN services and Taiwan internet gateway services. Total revenues for international data services were NT$0.7 billion, NT$0.8 billion and NT$1.0 billion (US$35.8 million) for 2008, 2009, 2010 respectively. Due to growth of the international corporations in Taiwan, we expect demand for IP VPN and Taiwan internet gateway services to continue to increase and our revenues from our international data services to continue to grow.

Satellite Services

We are a 50% owner of the ST-1 telecommunications satellite. Singapore Telecommunications Ltd. owns the remaining 50%. ST-1 was launched on August 26, 1998 and began commercial operations on December 1, 1998. We lease out transponder capacity on ST-1 and provide satellite lease circuits. In addition, we have two satellite communication centers that enable us to provide satellite value-added services and backup systems for use in major emergencies. We also provide satellite services to Southeast Asia. We are currently constructing the ST-2 telecommunications satellite together with Singapore Telecommunications Ltd. and plan to launch this satellite by the second quarter of 2011. We expect to retire the ST-1 telecommunications satellite after the launch of the ST-2 telecommunications satellite.

Chunghwa entered into a contract with ST-2 Satellite Ventures Pte., Ltd. on March 12, 2010 to lease capacity on the ST-2 satellite. The lease term is 15 years starting from the official start of operations of the ST-2 satellite, and the total contract value is approximately NT$6.0 billion (US$187.8 million). We have already prepaid NT$2.5 billion (US$86.4 million), which was classified as other assets – others. As of December 31, 2010, the ST-2 satellite is still under construction.

International Other Services

Our international other services include corporate solution service.

Others

Our others business segment include revenues from our non-telecom services, including our educational training programs and technology transfer income.

Interconnection

We provide interconnection of our fixed line network with other mobile operators and, since July 2001, with other fixed line operators.

 

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The following table sets forth our interconnection fee revenues and costs for the periods indicated. These revenues and costs are included, depending on the nature of the call made, in domestic fixed communications or mobile communications revenues and expenses, respectively.

 

     Year ended December 31  
     2008      2009      2010  
     NT$      NT$      NT$      US$  
            (in billions)             (in millions)  

Interconnection fee revenues:

           

Local

     2.5         2.5         2.4         82.8   

Domestic long distance

     0.8         0.4         0.3         11.8   

Mobile (1)

     7.7         7.5         7.9         269.9   

Interconnection costs:

           

Fixed line

     0.2         0.2         0.2         5.9   

Mobile

     7.1         7.2         7.4         255.5   

 

(1) Includes SMS air time charges.

Tariffs for telephone calls between our fixed line customers and mobile customers of other mobile operators are set by the mobile operators before 2010. The mobile operators pay us interconnection fees based on minutes of usage, regardless of who initiated the call. However, the National Communications Commission made amendments on August 4, 2010, stipulating the fixed line party who initiated the call to set the fees from January 1, 2011 onwards. Since we are the market leader of the local call services, in addition to the interconnection fees, we are required to pay transition fees to the mobile operators for a period of six years. The transition fees will decrease gradually over the period and we will stop paying for them in 2017.

The National Communications Commission approved new fixed line interconnection rates that became effective January 1, 2009. The interconnection rate for calls initiated by mobile customers to fixed line customers is NT$0.5219 per minute during peak times and NT$0.2718 per minute during off-peak times. The interconnection rate for calls initiated by fixed line customers to mobile customers is NT$0.8729 per minute during peak times and NT$0.6228 per minute during off-peak times. The interconnection rate between fixed line customers and other fixed line customers is NT$0.32 per minute during peak times and NT$0.09 per minute during off-peak times. The interconnection rate for fixed line customers to domestic or international long distance is NT$0.32 per minute.

In accordance with governmental regulations, the contracts governing our interconnection arrangements must specifically address a number of prescribed issues. For example, our interconnection charge should reflect our costs with respect to the network elements used. In addition, cost increases are subject to approval by the regulatory authorities. We expect that our interconnection contracts will generally be reviewed annually, although we may also enter into long-term contracts.

Cross-segment Businesses

We provide some services that cross our various business segments. These include our ICT services and telephone directory services.

Information and Communications Technology

Our information and communications technology, or ICT, services includes integrated services such as our Intelligent Energy Network, or iEN, and our Intelligent Transportation System, or ITS, services. Our iEN service helps companies and corporations implement energy saving measures through computer analysis of data. Our ITS service provides navigation, real-time traffic information and infotainment through mobile devices for cars and drivers. In addition to developing ICT businesses, such as iEN, ITS, IS, Call Center, IDC, we also pursue and bid for government projects aiming to boost economic development, for example, we had won the bid for “The New Generation Reform Project of Taxation Information Systems” launched by the Financial Data Center, Ministry of Finance in February 2010.

 

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Marketing, Sales and Distribution

Marketing Strategy

In order to retain and expand our large customer base and to encourage our customers to increase their use of our services and products, we continue to focus our marketing strategy on the following areas.

 

   

Services, Products and Bundled Offerings. We continually develop new value-added services and products, and bundle our services and products based on different market segments, with the aim of increasing our high-usage customers and enhancing customer loyalty. For example, we entered into an agreement with Apple Inc. and are currently a reseller of the iPhone 3G, iPhone 3GS and iPhone4 in Taiwan. We anticipate that the iPhone 3G, iPhone 3GS and iPhone 4, combined with our mPro service, will attract market attention, spur new customer growth, help retain existing customers and generate revenues through the increased use of our value-added services.

 

   

Pricing and Promotions. We design flexible pricing packages that allow customers to select structures best tailored to their usage patterns, and design special promotional packages to encourage usage. For example, we have provided our “Friends and Family”, “Genki Plan”, “Let’s Talk” and “My Hotline” promotion package to attract mobile customers.

 

   

Distribution Channels. We seek to facilitate customer subscription by adding more service points. In addition, we seek to broaden our distribution reach by strengthening our cross-industry alliances and marketing relationships. Furthermore, we seek to expand our sales channels by implementation of a sales agent system. In 2009, we began a collaboration with Tsann Kuen Trans-Nation Group, allowing the registration of mobile numbers at electronics stores for the first time, effectively increasing our points of sale. We also developed staff incentive programs to better motivate our sales staff.

 

   

Business Customers. We expanded our customer focus to include small and medium-sized enterprises in addition to large corporations. We seek to serve the needs of large corporate customers by devoting a project manager or project engineer to service these customers. These account managers are responsible for developing customized solutions and tariff packages to meet the specific needs of our customers. We continually update and expand our service offerings so that we can remain a one-stop telecommunications services provider to our corporate customers and provide for all of their telecommunications needs. Our dedicated local teams serve the needs of small and medium-sized enterprises. These teams also use our data bank to identify and target potential clients for promoting our e-commerce and mobile services. In addition, we help our corporate customers improve their efficiency and competitiveness by creating information systems for them.

 

   

Advertising. We are committed to further strengthening the Chunghwa Telecom brand and image as well as strengthening and expanding market recognition of our specialized product brands, such as HiNet and emome. We plan to leverage our leading market position and status to strengthen the overall advantage of our product brands.

Sales and Distribution

Our marketing department at our corporate headquarters in Taipei is responsible for central business planning and formulating our marketing strategies and objectives. We have multiple marketing departments for our various businesses which are responsible for business and marketing planning.

We also have 23 operations offices, 313 service centers and 221 exclusive service stores located throughout Taiwan that are responsible for operations, sales and customer service in their respective local areas.

 

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Customer Service and Billing

We believe our reputation for quality customer service has helped us attract new customers and maintain customer loyalty. We regularly survey our customers to improve our service and better understand market demand and customer preferences, and seek to develop products and services accordingly.

We provide the following services to our customers:

 

   

24-hour customer service and technical support through our service centers, call centers and website;

 

   

English billing documents available upon request;

 

   

free of charge itemized billing for international and domestic long distance calls;

 

   

bill payment services at 24-hour convenience stores, bank service counters, automatic teller machines, and service centers throughout Taiwan, via direct debit, over the phone, online at our website (www.cht.com.tw), on MOD, and on mobile handset emome;

 

   

online information and bill payment services at our website (www.cht.com.tw) and customer service hotline for telephone payment; and

 

   

consolidated and automated billing for all services.

Network Infrastructure

Our network infrastructure consists of transmission networks that convey voice and data traffic, switching networks that route traffic between networks, and mobile, paging, internet, leased line and data switching networks.

We purchase most of our network equipment from well-known international suppliers. As part of the purchase contract, these suppliers deliver and install the equipment for us. We also purchase from local suppliers a variety of components such as transmission lines, switches, telephone sets, MOD set-top boxes, and radio transmitters.

Approximately 13,900 of our employees were engaged in network infrastructure development, maintenance, operation and planning as of December 31, 2010.

Internet Protocol Broadband Backbone Network

Our internet protocol broadband backbone network consists of an inner core network and an outer core network. We completed the construction of our high-speed internet protocol backbone network at the end of 2010 with 14 sets of 2.5 Tbps/1.2Tbps gigabit switch routers for the inner core network and more than 54 sets of 1.2Tbps /640 Gbps/320 Gbps/80 Gbps gigabit switch routers for the outer core network. We believe this network will enable us to meet the increasing demand for broadband access and broadband multimedia services.

Transmission Networks

As of December 31, 2010, our transmission networks consisted of approximately 1.26 million fiber kilometers of fiber optic cable for trunking and approximately 3.33 million fiber kilometers of fiber optic cable for local loop.

 

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Synchronous digital hierarchy architecture is an advanced technology that allows for instantaneous rerouting and eliminates downtime in the event of a fiber cut. In addition, synchronous digital hierarchy offers better reliability and performance for optical fiber transmissions at a lower operating cost. In December 2002, we installed synchronous transport module 64 multiplexer and 32-wavelength dense wavelength division multiplexing equipment on our long-haul backbone network. Our synchronous transport module 64 multiplexer can multiplex several low speed signals into a 10 gigabits per second, or Gbps, high-speed signal. Dense wavelength division multiplexing equipment uses a technology that puts data from different sources together on an optical fiber with each signal carried on its own separate wavelength. Both synchronous transport module 64 multiplexer and dense wavelength division multiplexing equipment can increase our network capacity. Furthermore, between 2003 and 2007, we deployed 32-wavelength optical add-drop multiplexer rings in Taipei, Taichung, Tainan and Kaohsiung. Between 2007 and 2011, we will deploy 40/80-wavelength Re-configurable Optical Add-Drop Multiplexer, or ROADM, rings for backbone transmission network in order to provide new data services such as gigabit Ethernet, fiber channel, 2.5 gigabit and 10 gigabit packet over synchronous digital hierarchy and 10 gigabit Ethernet. We have already completed the deployment of 397 wavelength ROADM rings by the end of 2010. To meet the demand for broadband services, we will install an optical cross-connect, or OXC, network and a next generation synchronous digital hierarchy network, which provides gigabit Ethernet over synchronous digital hierarchy service, between 2009 and 2013.

Based on the transmission network described above, we have been providing connection circuit service of 10 gigabit packet over synchronous digital hierarchy and 10 gigabit Ethernet to the government’s Taiwan Advanced Research and Education Network since November 2006 and continued the service until November 2012.

As part of our strategic focus on the internet and data markets, our local loop connections use ADSL technology. This enables us to deliver high-speed internet, multimedia and other data services to our customers. Substantially all of our installed telephone lines are capable of delivering ADSL services. As of December 31, 2010, we had approximately 4.61 million lines of ADSL and had 2.32 million ADSL customers. In addition, the Ethernet-based FTTx system is also introduced into our access network to provide broadband services, such as MOD, high speed internet access and VPN. As of December 31, 2010, we have constructed approximately 3.36 million FTTx ports and had 2.04 million FTTx customers. Our FTTx service can offer high-speed broadband internet access rates up to 100 Mbps.

Switching Networks

Domestic telecommunications network. Our domestic public switched telephone network consists of 19 message areas connected by a long distance network. As of December 31, 2010, we had 38 long distance exchanges, which are interconnection points between our telecommunications network.

In 2010, we expanded our NGN core network capacity, accommodating 560,000 local telephone subscribers, comprising of 448,000 Session Initiation Protocol-based, or SIP-based, and 112,000 Access Gateway-based, or AG-based, subscribers. In 2010, we initiated a new extension of 238,100 AG-based subscribers. AG-based subscribers will be provided with the original services. SIP-based subscribers access the NGN core network through broadband circuits and will have access to innovative value-added services in the future along with the original services.

Our NGN Managed IP backbone network consists of an inner core network and an outer core network. We completed the construction of our high-speed NGN Managed IP backbone network at the end of 2010 with 12 sets of 640 Gbps gigabit switch routers for the inner core network and more than 24 sets of 640 Gbps gigabit switch routers for the outer core network. The bandwidth of the network is approximately 550 Gbps as of the end of 2010. We believe this network will enable us to meet the increasing demand for NGN services, such as VoIP, and all managed services, including MOD and VPN.

We currently have intelligent networks installed over our public switched telephone networks for our domestic long distance and international networks, as well as a local intelligent network in the Taipei, Taichung and Kaohsiung metropolitan areas. Our intelligent network is designed to facilitate the use of value-added services by providing more information about calls and allowing greater management of those calls.

As of December 31, 2010, our domestic network included 17.5 million installed telephone lines, and reached virtually all homes and businesses in Taiwan.

 

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International network. Our international transmission infrastructure consists of both submarine cable and satellite transmission systems, which link our national network directly to 101 telecommunications service providers in 45 international destinations.

International calls are routed between Taiwan and international destinations through one of our two international switching centers, one located in Taipei and the other in Kaohsiung. Each center had two time-division multiplexing, or TDM, international gateway switches and one NGN international gateway switch. In total, we had a trunk capacity of 125,040 channels as of December 31, 2010.

As of December 31, 2010, we have invested in 14 submarine cables, seven of which land in Taiwan. While the number of submarine cables we invest in has decreased from 16 in 2009, we have increased the capacity of each of our current submarine cables, increasing our aggregate total capacity from 596 Gbps in 2009 to 774 Gbps in 2010.

Mobile Services Network

Our mobile services network consists of:

 

   

cell sites, which are physical locations equipped with a base station consisting of transmitters, receivers and other equipment used to communicate through radio channels with customers’ mobile handsets within the range of a cell;

 

   

BSC (base station controllers) for GSM or RNC (radio network controller) for 3G, which connect to, and control , the base station within each cell site;

 

   

base station controllers, which connect to, and control, the base station within each cell site;

 

   

cellular switching service centers, which control the base station controllers and the processing and routing of telephone calls;

 

   

GGSN (gateway GPRS support nodes), which connect our GPRS network to the internet;

 

   

SGSN (serving GPRS support nodes), which connect the GPRS network to the base station controllers; and

 

   

transmission lines, which link (i) with respect to the GSM or 3G network, the mobile switching service centers, base station controllers, base stations and the public switched telephone network, and (ii) with respect to the GPRS network, the base station controllers, the support nodes and the internet.

The following table sets forth selected information regarding our mobile networks as of the dates indicated.

 

     As of December 31,  
     2008     2009     2010  

GSM system

      

GSM base stations

     9,466        9,384        9,336   

Switches

     49        49        44   

Lines of capacity (in thousands)

     8,500        7,700        6,500   

Taiwan population coverage

     99.9     99.9     99.9

 

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     As of December 31,  
     2008     2009     2010  

3G system

      

3G base stations

     5,689        6,243        6,879   

Servers / gateways

     8/11        8/15        8/16   

Lines of capacity (in thousands)

     3,000        3,000        3,450   

Taiwan population coverage

     91.0     93.1     94.5

System (Home Location Register) capacity (in thousands)

     4,800        5,400        7,200   

 

     As of December 31,  
     2010  

Packet-switched system after consolidation of GSM and 3G

  

GPRS gateway support nodes

     14   

Direct IP access locations / capacity (in Gbps)

     10/46.6   

Serving support nodes

     12   

We provide mobile services based on the GSM network standards. We have the 900 MHz and 1800 MHz frequency bands paired with spectrums of 15 MHz and 11.25 MHz, respectively, for our GSM services. We began providing mobile communications services based on the GPRS network standards in August 2001, using “emome” as the portal name. We completed a system expansion of our mobile services network to accommodate more than 8.5 million customers, including 2.0 million GPRS customers, at the end of 2003. As of December 31, 2010, we have constructed 9,336 base stations, providing up to 99.9% population coverage. Since the launch of our 3G mobile services, we have gradually transitioned GSM subscribers to 3G and have started to consolidate our GSM network. As a result, the number of switches and network capacity has reduced to 44 and 6.5 million lines, respectively, as of the end of 2010.

We have installed an intelligent network on our mobile services network infrastructure to enable us to provide prepaid services as well as a wide range of advanced call features and value-added services. As of the end of 2010, our intelligent network has 1.4 million prepaid customers and 1.2 million mobile virtual private network customers.

We have 15 MHz paired spectrum plus 5 MHz unpaired spectrum in the 2 GHz frequency band for our 3G mobile services, which was launched in July 2005. We contracted Nokia Siemens Networks to provide the core network, radio access network, service network, transmission network and maintenance network for our 3G network. To promote mobile internet use, we upgraded our network to 3.5G in September 2006, with downlink and uplink speeds of 7.2 Mbps and 2.0 Mbps, respectively. To meet the high growth in mobile data traffic, we have upgraded our existing High-Speed Packet Access (HSPA with capability of 14.4Mbps and 5.76Mbps each for Down-link and Up-link) Network to HSPA+ (with capability of 21.6Mbps and 11.5Mbps each for Down-link and Up-link). As of December 31, 2010, we have completed the construction of 6,879 3G base stations with a network capacity of 3.45 million lines and 7.2 million subscribers.

In order to operate our packet-switched network more efficiently, we have consolidated GSM and 3G serving GPRS support nodes (SGSN) into a single core network. We have also introduced the Direct Tunnel technology to flatten the packet-switched network to enhance the user’s experience. With the introduction of high speed networks and terminals to promote our mobile internet business, we added direct local IP access to eight locations and expanded the capacity to 46.6 Gbps as of the end of 2010.

Paging Network

The primary components of our paging network are:

 

   

paging control systems, which receive and encode incoming messages; and

 

   

base stations, which transmit messages to the customer’s pager.

 

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Our paging network uses, among other technologies, the open paging protocol developed by Motorola. This technology provides higher data rate, larger content capacity, longer battery life and better error correction capabilities than other existing paging technologies. We plan to discontinue our paging service after migrating paging service subscribers to our 3G network by using incentives. After negotiations between us and the NCC, the NCC has agreed to hold a public hearing if we want to close the system earlier than the license expiration day May 5, 2013. This process is still in progress.

Internet Network

HiNet, our internet service provider, has the largest internet access network in Taiwan, with 33 points of presence, approximately 1,808 dial-up ports, approximately 5,462,000 broadband remote access server ports and a backbone bandwidth of approximately 1,348 Gbps as of December 31, 2010. We plan to increase HiNet’s points of presence and backbone bandwidth to approximately 1,740 Gbps by the end of 2011.

HiNet’s total international connection bandwidth is 260.6 Gbps as of December 31, 2010. As we expect that internet traffic flows to and from the United States will continue to increase, we plan to expand our bandwidth to the United States. We also plan to increase our links to other countries, including Japan, Korea, Hong Kong, Singapore, Mainland China, Malaysia and Thailand.

Leased Line and Data Switching Networks

We operate leased line networks on both a managed and unmanaged basis. In addition, we operate a number of switched digital networks used principally for the provision of packet-switched, frame relay, asynchronous transfer mode technology and a multi protocol label switching internet protocol VPN. We have completed the construction of a digital cross connect system for provisioning and managing voice-grade data services throughout Taiwan with a total of 50 nodes. As of December 31, 2010, we had 695 frame relay ports, 3,118 X.25 ports, 8,095 asynchronous transfer mode ports and approximately 63,835 multi protocol label switching internet protocol VPN virtual ports.

Our data networks support a variety of transmission technologies, including X.25 protocol, frame relay and asynchronous transfer mode technology. We have also built up our HiLink VPN that combines internet protocol and asynchronous transfer mode technologies. The advantage of a HiLink VPN based on multi protocol label switching technology is that it can carry different classes of services, such as video, voice and data together to provide services with various qualities of service, high performance transmission and fast forward solution in an enhanced security network. A HiLink VPN can be accessed by an ADSL and can include built-in mechanisms that can deal with overlapping internet protocol addresses. Therefore, the network potentially is less costly and requires less management for business applications.

Competition

We face competition in virtually all aspects of our business.

Domestic Fixed Communications

We are the largest domestic fixed communications service provider in Taiwan, with a market share of approximately 96.9% in terms of customers for local telephone services, approximately 76.1% in terms of traffic for domestic long distance telephone services in 2010, and approximately 80.5% share of the broadband internet access market in terms of customers. Three new providers, namely, Taiwan Fixed Network, New Century Infocomm Tech. Co., Ltd. and Asia Pacific Telecom Co. Ltd., have provided fixed communication services since June 2001. Our domestic long distance services compete with mobile services as people increasingly use mobile handsets. We believe that the fixed line competition in Taiwan will be primarily based on price, quality of service, network coverage and customer services, such as call centers and unified billing.

We are required by Republic of China regulations to provide number portability and unbundled local loop access.

 

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Our primary competitors in leased line services and broadband services include:

 

   

Leased line service providers: Taiwan Fixed Network, New Century Infocomm Tech. Co., Ltd., Asia Pacific Telecom Co. Ltd., East Asia Netcom Taiwan, Reach Global Services Ltd., FLAG Telecom and Taiwan International Gateway Corporation.

 

   

Broadband internet access providers: kbro Co., Ltd., Taiwan Fixed Network and New Century Infocomm Tech. Co., Ltd., China Network System Co., Ltd.; and

 

   

Cable operators: kbro Co., Ltd., China Network Systems Co., Ltd., Taiwan Broadband Communications Co., Ltd., Pacific Broadband Co., Ltd., and Taiwan Infrastructure Technology Co., Ltd.

Mobile Communications

There are currently three major GSM mobile operators in Taiwan, namely, Taiwan Mobile Co., Ltd., FarEasTone Telecommunications Co., Ltd. and us. Based on data provided by the National Communications Commission, as of December 31, 2010, we were the largest mobile operator in Taiwan, with a 51.9% market share in terms of 2G customers. In addition, there are two new 3G mobile operators in Taiwan, namely Asia Pacific Telecom Co., Ltd. and Vibo Telecom Inc., as well as one personal handyphone system operator, First International Telecom. Furthermore, the government issued a total of 15 mobile virtual network operator, or MVNO, licenses, which allow operators without a spectrum allocation to provide mobile services by leasing the capacity and facilities of a mobile service network from a licensed mobile service provider. We are currently cooperating with Carrefour Telecom Co., Ltd. We may cooperate with other mobile virtual network operators in the future. As of the end of 2010, there were also six WiMAX service providers in Taiwan, providing services to approximately 55,000 customers in total according to the data provided by the National Communications Commission. We compete in the wireless services market primarily on the basis of price, quality of service, network reliability and attractiveness of service packages.

Internet

Our primary competitors in internet services are other internet services providers, including SeedNet, Asia Pacific Online.

We are the largest provider of internet services in Taiwan. As of December 31, 2010, we had a 69.6% share of the Taiwanese internet service market in terms of customers. We compete in the internet services market primarily on the basis of price, technology, speed of transmission, amount of bandwidth available for use, network coverage and value-added services.

International Fixed Communications

We are the largest international fixed communications service provider in Taiwan, with a market share of approximately 58.4% in terms of traffic for international long distance telephone services in 2010. Three new providers, namely, Taiwan Fixed Network, New Century Infocomm Tech. Co., Ltd. and Asia Pacific Telecom Co. Ltd., have provided fixed line services since June 2001. We believe these operators are primarily focused on international long distance services. In addition, we anticipate that these operators will focus on corporate customers, which typically generate higher profit margins than residential customers. Since August 2001, four undersea cable services licenses have been granted. These undersea cable operators, as well as internet service providers and international simple resale operators, have begun offering international leased line services to other fixed line operators, internet service providers and international simple resale operators.

Our international long distance services compete with international long distance resale services and alternative mediums for making international calls, including VoIP technologies, such as those provided by Skype.

 

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Properties

Our properties consist mainly of land, land improvements and buildings located throughout Taiwan. We own approximately 411 hectares of land and 3.5 million square meters of building floor space. In January 2008, we established Light Era Development Co., Ltd. for the purpose of developing our real estate properties. Until now, we have transferred six properties to Light Era. Five of these properties are under development. The Wan-Xi project, Li-Shui B project and LightEra-Covent Project are expected to be completed in 2011 and the Guang-Dian project and Li-Shui A project are expected to be completed in 2012. Following the gradual completion of land rezoning, we have focused our real estate development more towards multiuse and diverse projects. Hence, besides the six properties we transferred to Light Era, we have developed more properties for commercial use and participated in government urban redevelopment plans. We expect to receive approximately NT$575 million (US$19.7 million)] in rental income in 2011 from such properties.

Insurance

We do not carry comprehensive insurance for our properties or any insurance for business disruptions. We do, however, maintain in-transit insurance for key materials, such as cables, equipment and equipment components. We also carry insurance for the ST-1 satellite while it is in orbit. However, we will not carry insurance for the ST-2 satellite since we only lease the repeaters for our operation instead of owning the ST-2 satellite.

Employees

Please refer to “Item 6. Directors, Senior Management and Employees—D. Employees” for a discussion of our employees.

Our Pension Plans

Currently, we offer two types of employee retirement plans—our defined contributions plan and defined benefits plan—which are administered in accordance with the Republic of China Labor Standards Act and the Republic of China Labor Pension Act.

Legal Proceedings

A portion of the land used by us during the period between July 1, 1996 and December 31, 2004 was jointly owned by us and Chunghwa Post Co., Ltd., Directorate General of Postal Service. In accordance with the claims process in Taiwan, on July 12, 2005, the Taiwan Taipei District Court sent a claim notice to us requiring us to reimburse Chunghwa Post Co., Ltd. in the amount of NT$768.0 million for land usage compensation due to the portion of land usage area in excess of our ownership, along with interest calculated at 5% interest rate from June 30, 2005 to the payment date. However, we believe that both parties have the right to use co-managed land without consideration and thus Chunghwa Post Co., Ltd. does not have the right to request land compensation payments. Furthermore, we also believe that the computation used to derive the land usage compensation amount is inaccurate because most of the compensation amount has expired as a result of the expiration clause. On March 30, 2009, the Taiwan Taipei District Court rendered its judgment that we only need to pay approximately NT$17 million (USS$0.5 million), along with interest calculated at 5% per annum from July 23, 2005, and 4% of Chunghwa Post Co., Ltd.’s court fees as compensation. Chunghwa Post Co., Ltd. appealed to the Taiwan High Court on April 22, 2009. We also filed an appeal to the Taiwan High Court within the statutory period. On April 7, 2010, the Taiwan High Court rendered its judgment, ruling that we need to pay approximately NT$23 million (US$0.7 million), in addition to the approximately NT$17 million from the Taiwan Taipei District Court judgment, along with interest calculated at 5% per annum from July 23, 2005, and 12.5% of Chunghwa Post Co., Ltd.’s court fees from its original suit and subsequent appeal as compensation. We filed an appeal with the Supreme Court on April 22, 2010 and the case is now going under trial in the Supreme Court.

On September 30, 2008, the Taiwan Kaohsiung Administrative High Court ruled that we are required to pay NT$428 million in land usage fees to the Kaohsiung City Government. During the quarter ending December 31, 2009, we recognized the maximum possible amount of NT$428 million in connection with this litigation as an expense under operating costs. On June 22, 2010, the Supreme Administrative Court judged that we should pay the land usage fees to the Kaohsiung City Government, and we have made the payment accordingly.

 

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We are involved in various legal proceedings of a nature considered in the ordinary course of our business. It is our policy to provide for reserves related to these legal matters when it is probable that a liability has been incurred and the amount is reasonably estimable.

We believe that the various asserted claims and litigation in which we are involved will not materially affect our financial condition or results of operations although no assurance can be given with respect to the ultimate outcome of any such claim or litigation.

Capital Expenditures

See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures” for a discussion of our capital expenditures.

Enforceability of Judgments in Taiwan

We are a company limited by shares and incorporated under the Republic of China Company Law and the Statute of Chunghwa Telecom Co., Ltd. All of our directors and executive officers, our supervisors and some of the experts named in this annual report are residents of Taiwan and a substantial portion of our assets and the assets of those persons are located in Taiwan. As a result, it may not be possible for investors to effect service of process upon us or those persons outside of Taiwan, or to enforce against them judgments obtained in courts outside of Taiwan. We have been advised by our Republic of China counsel that in their opinion any final judgment obtained against us in any court other than the courts of the Republic of China in connection with any legal suit or proceeding arising out of or relating to the ADSs will be enforced by the courts of the Republic of China without further review of the merits only if the court of the Republic of China in which enforcement is sought is satisfied that:

 

   

the court rendering the judgment has jurisdiction over the subject matter according to the laws of the Republic of China;

 

   

the judgment and the court procedure resulting in the judgment are not contrary to the public order or good morals of the Republic of China;

 

   

if the judgment was rendered by default by the court rendering the judgment, we were served within a reasonable period of time in accordance with the laws and regulations of the jurisdiction of the court or process was served on us with judicial assistance of the Republic of China; and

 

   

judgments at the courts of the Republic of China are recognized and enforceable in the court rendering the judgment on a reciprocal basis.

A party seeking to enforce a foreign judgment in the Republic of China would be required to obtain foreign exchange approval from the Central Bank of the Republic of China (Taiwan) for the payment out of Taiwan of any amounts recovered in connection with the judgment denominated in a currency other than NT dollars if a conversion from NT dollars to a foreign currency is involved.

Regulation

Overview

We were subject to the Statute of Chunghwa Telecom Co., Ltd. prior to our privatization. Although we have been privatized, the Legislative Yuan has not yet abolished the Statute of Chunghwa Telecom Co., Ltd., and at this time, the Statute of Chunghwa Telecom Co., Ltd. is still applicable to us.

 

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Regulatory Authorities

Prior to March 1, 2006, we were under the supervision of the Ministry of Transportation and Communications and the Directorate General of Telecommunications. On March 1, 2006, the National

Communications Commission was formed in accordance with the National Communications Commission Organization Law, or the Organization Law, which was intended to transfer regulatory authority over the Taiwan telecommunications industry from the Ministry of Transportation and Communications and the Directorate General of Telecommunications to the National Communications Commission. The National Communications Commission was comprised of nine commissioners who were recommended by the government and opposition political parties in the Legislative Yuan, as well as recommended by the Executive Yuan and approved by the Legislative Yuan. However, the Executive Yuan considered the composition of the National Communications Commission unconstitutional and petitioned the Grand Justices of the Republic of China, or the Grand Justices, to interpret the constitutionality of the formation of the National Communications Commission and the procedure for nominating commissioners to serve on the National Communications Commission. On July 21, 2006, the Grand Justices rendered an interpretation and held that the relevant provisions under the Organization Law as to the nomination procedures for the commissioners of the National Communications Commission were unconstitutional. However, the Grand Justices granted a grace period allowing such provisions of the Organization Law to remain in effect until December 31, 2008.

On January 9, 2008, an announcement issued by the President amended the Organization Law, or New Amendment, amending the unconstitutional formation articles and reducing the total number of commissioners to seven with a term of four years, but three of the commissioners appointed after the New Amendment are with a term of two years. The commissioners will be nominated by the premier of the Executive Yuan and approved and appointed by the Legislative Yuan.

The new nomination method under the New Amendment became effective on February 1, 2008 when the Legislative Yuan started its new term. The nine incumbent commissioners continued to serve until July 31, 2008, when their terms ended. The premier of the Executive Yuan nominated seven commissioners on July 1, 2008, and they were approved and appointed by the Legislative Yuan on July 18, 2008. The new commissioners took office on August 1, 2008. Thereafter, upon the resignation of one commissioner and the expiry of the term for the three commissioners, four new commissioners were nominated by the premier of the Executive Yuan, approved and appointed by the Legislative Yuan and began serving as commissioners on August 1, 2010.

In accordance with the National Communications Commission Organization Law, the National Communications Commission is responsible for:

 

   

formulating, implementing and interpreting telecommunications laws and regulations;

 

   

issuing telecommunications licenses and regulating the operation of telecommunications industry participants;

 

   

assessing and testing telecommunication systems and equipment;

 

   

drafting and promulgating technical standards for telecommunications and broadcasting;

 

   

classifying and censoring the contents of telecommunications and broadcasting;

 

   

managing telecommunications and media resources in Taiwan;

 

   

maintaining competition order in the telecommunication and broadcasting industries;

 

   

governing technical standards in connection with the safety of information communications;

 

   

managing and facilitating the resolution of disputes pertaining to the Taiwan telecommunications and broadcasting industries;

 

   

managing offshore matters relating to Taiwan’s telecommunications and broadcasting industries including matters of international cooperation;

 

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managing funds allocated for the development of Taiwan’s telecommunications and broadcasting industries;

 

   

monitoring, investigating and determining matters in relating to Taiwan’s telecommunications and broadcasting industries;

 

   

enforcing restrictions under telecommunications and broadcasting laws and punishing violators; and

 

   

supervising other matters in relation to communications and media.

Telecommunications Act

The Telecommunications Act and the regulations under the Telecommunications Act establish the framework and govern the various aspects of the Taiwan telecommunications industry, including:

 

   

licensing of telecommunications services;

 

   

telecommunication numbers;

 

   

restrictions on dominant telecommunications service providers;

 

   

tariff control and price cap regulation;

 

   

accounting separation system;

 

   

interconnection arrangements;

 

   

bottleneck facilities;

 

   

spectrum allocation;

 

   

provision of universal services;

 

   

equal access;

 

   

number portability;

 

   

local loop unbundling;

 

   

co-location; and

 

   

ownership limitations.

Each of these aspects is described below. The Telecommunications Act also establishes a non-auction pricing system for assignment of radio frequencies.

Licensing of Telecommunications Services

Type I and Type II Service Providers

Under the Telecommunications Act, telecommunications service providers are classified into two categories:

Type I. Type I service providers are providers that install network infrastructure, such as network transmission, switching and auxiliary equipment for the provision of telecommunications services. Type I services include fixed line services such as local, domestic long distance and international long distance services, as well as interconnection, leased line, ADSL and satellite services and wireless services such as mobile, including 3G mobile, paging, mobile data and trunked radio services.

 

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Type II. Type II service providers are defined as all telecommunications service providers other than Type I service providers. Type II services are divided into special services and general services. Special services include simple resale, VoIP international leased circuit and other services specified by the Ministry of Transportation and Communications before March 1, 2006 or by the National Communications Commission from March 1, 2006. General services include any Type II service other than special services.

Until 1996, we were the sole provider of Type I services in Taiwan. In 1996, the government opened the market for mobile, paging and trunked radio, mobile data and digital low power cordless telephone services. In 1998, the government opened the market for fixed line and mobile satellite services. In June 2001, the government granted licenses to three operators for establishing fixed line services, thereby opening the market for fixed line services. Since August 2000, the government has permitted four undersea cable operators to engage in the undersea cable leased-circuit business.

Commencing in 2007, the National Communications Commission began accepting applications for licenses to provide fixed line services in March, June, September and December of each year. The National Communications Commission started to accept applications for fixed line services on a daily basis beginning in 2008. There is no limit on the number of fixed line licenses that they may decide to issue.

Granting of Licenses

Type I

Type I service providers are more closely regulated than Type II service providers. The government has broad powers to limit the number of providers and their business scope and to ensure that they meet their facilities roll-out obligations. Under the Telecommunications Act, Type I service providers are subject to pre-licensing merit review of their business plans and tariff rates.

Before March 1, 2006, licenses for Type I services were granted by the Ministry of Transportation and Communications through a three-step procedure. Applicants obtained a concession from the Ministry of Transportation and Communications. After obtaining a concession, the applicant obtained a network construction permit and an assignment of spectrum, in the case of mobile telephone services and satellite services, from the Directorate General of Telecommunications or the Ministry of Transportation and Communications prior to applying for a license. Upon completion of construction of its network and review by the Directorate General of Telecommunications, the applicant was granted a Type I license. The Ministry of Transportation and Communications had the authority to grant Type I licenses for each of fixed line services, wireless services and satellite services. Type I licenses have different minimum paid-in capital requirements for applicants and varying durations depending on the particular type of service.

Since March 1, 2006, the same procedure applies except that the licenses are granted by the National Communications Commission.

The Telecommunications Act further authorizes the competent authority, now the National Communications Commission, to promulgate separate regulations governing each Type I service, including the business scope of the Type I service provider, as well as the procedures and conditions for granting special permits and the length of the period of the special permits of each Type I service. Each holder of a Type I license will pay a fee ranging from 0.5% to 2% of or their bid price ratio (Article 2 of the Type I Service Provider Special Tariff Standards) multiplied by their annual revenues generated from the particular Type I service for which a license has been granted.

 

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Fixed Line Services. Under the Telecommunications Act, the Fixed Network Regulations govern the issuance of fixed line service licenses and the business scope of fixed line providers. Fixed line service licenses are subdivided into the following categories:

 

   

integrated services, including local, domestic long distance, international long distance telephone services;

 

   

local telephone services;

 

   

domestic long distance telephone services;

 

   

international long distance telephone services; and

 

   

local, domestic long distance and international long distance leased line services. We conduct our fixed line services through a license for integrated services.

Licenses for local telephone and integrated services are valid for 25 years. Licenses for domestic long distance and international long distance telephone services are valid for 20 years. Licenses for leased line services are valid for 15 years. If the service provider wishes to continue operating, the service provider needs to apply for a license renewal to the National Communications Commission between nine months and six months before the expiration of their license. The minimum paid-in capital requirements for integrated services providers that applied for a license before June 30, 2004, between July 1, 2004 and January 31, 2008 and on or after February 1, 2008 are NT$21 billion, NT$8.4 billion and NT$6.4 billion, respectively. The minimum paid-in capital requirements for both domestic and international long distance telephone service providers that applied for a license between July 1, 2004 and January 31, 2008 and on or after February 1, 2008 are NT$1.05 billion and NT$800 million, respectively. The minimum paid-in capital requirements for international undersea leased cable service providers that applied for a license before June 30, 2004, between July 1, 2004 and January 31, 2008 and on or after February 1, 2008 are NT$420 million, NT$420 million and NT$320 million, respectively. The minimum paid-in capital requirement for local telephone service providers that applied for a license between July 1, 2004 and January 31, 2008 and on or after February 1, 2008 are NT$6.3 billion and NT$4.8 billion, respectively, multiplied by the Local Network Operation Weights for the regions in which local network managerial rights have been granted to the service provider. The Local Network Operation Weights are calculated as the population of the region as a proportion of the entire population of Taiwan and are announced by the competent authority every three years. If an applicant for license is also a Type I service provider, they will need to combine the minimum paid-in-capital requirements for all relevant services.

In March 2000, the government granted three new concessions to fixed line services providers for integrated services. Recipients of these concessions are required to apply for a network construction permit to deploy broadband local access networks. Each recipient of these concessions is required to have capacity for 150,000 customers before they are able to apply for a fixed line license to launch their proposed services. The three fixed line service providers have since obtained fixed line licenses and are required to achieve capacity for one million customers by the sixth year following the date of the grant of the network construction permit awarded. Operators that applied for integrated service provider licenses before June 30, 2004, between July 1, 2004 and January 31, 2008 and on or after February 1, 2008 must achieve a capacity for 1.0 million, 0.4 million and 0.3 million customers, ports or a combination of both, respectively, by the fourth year following the date of the grant of the network construction permit.

Wireless Services. Under the Telecommunications Act, the Wireless Regulations promulgated by the Ministry of Transportation and Communications before March 1, 2006 or by the National Communications Commission from March 1, 2006 continue to govern the issuance of wireless services licenses and the business scope of wireless service providers. Wireless service licenses are subdivided into the following categories:

 

   

mobile services;

 

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paging services;

 

   

mobile data services;

 

   

digital low-power cordless telephone services; and

 

   

trunked radio services.

Wireless service licenses are granted to both regional and national service providers through review and bidding procedures.

Wireless services licenses for mobile and paging services are valid for 15 years, and licenses for mobile data, digital low-power cordless telephone and trunked radio are valid for ten years. The minimum paid-in capital requirement for regional mobile service providers and national mobile service providers is NT$2 billion and NT$6 billion, respectively.

We are licensed to provide mobile and paging services in Taiwan.

Third Generation Mobile Services. The Ministry of Transportation and Communications promulgated the Third Generation Mobile Telecommunications Services Regulations on October 15, 2001. The National Communications Commission amended the above regulations on July 5, 2007, designating itself as the authority in charge of the third generation, or 3G, mobile services regulations and further amended such regulations on December 30, 2008 for the establishment of base stations. The regulations govern voice and non-voice telecommunications services provided using the spectrum assigned by the Ministry of Transportation and Communications, and now governed by the National Communications Commission, that utilizes the IMT-2000 technical standards as announced by the International Telecommunications Union. Licenses for 3G mobile services were granted by the Ministry of Transportation and Communications and are now granted by the National Communications Commission. We have received our 3G mobile services license, which is valid from May 26, 2005 to December 31, 2018.

Under the Third Generation Mobile Telecommunications Services Regulations, a company holding a 3G mobile license and having 200 or more shareholders is required to become a public company, which is subject to the stringent disclosure requirements under the securities regulations of the R.O.C. A company holding a 3G mobile license is also required to submit a report to the National Communications Commission within 20 days after its shareholders approves the capital reduction of such company, the entering into, modification or termination of any contracts regarding leasing of all business, outsourcing of operations or joint operations, the transfer of the whole or substantial part of business or assets of such company, taking over of the whole of the business or assets of any other company which would have significant impact on such company’s operations. The National Communications Commission revised the Third Generation Mobile Telecommunications Services Regulations on January 20, 2010 to add additional regulations regarding audio-visual content and provision, including requiring service providers who set up a platform for audio-visual content providers to sell content, duly notify customers the costs and charges of using these audio-visual content and limit access of inappropriate content to minors. The National Communications Commission further amended the Third Generation Mobile Telecommunications Service Regulations on December 28, 2010 to remove the clauses in relation to base station which have been regulated by the new enacted Regulations Governing Base Stations for Wireless Services.

Satellite Services. Under the Telecommunications Act, the Satellite Regulations promulgated by the Ministry of Transportation and Communications govern the issuance of satellite services licenses and the business scope of satellite service providers. The National Communications Commission amended the above regulations on July 20, 2007, designating itself as the authority in charge of the Satellite Regulation. Satellite services licenses are subdivided into fixed satellite services licenses and mobile satellite services licenses.

 

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Satellite services licenses are valid for 10 years. Minimum paid-in capital requirements for fixed satellite services providers and mobile satellite services providers are NT$100 million and NT$500 million, respectively.

We currently hold a fixed satellite services license, valid from December 10, 2008 to December 9, 2018.

Type II

The Telecommunications Act was amended in 1996 to open the market for all Type II services. Under the Type II Services Regulations as last amended on November 5, 2010, Type II services are divided into special services and general services. Special services include simple resale, VoIP, network telephone service of E.164 and non-E.164 user numbers (IP Phone Numbers), international leased circuit and other services specified by governing authority. General services include any Type II service other than special services. The policy for granting a Type II service license is as follows:

 

   

there is no limit on the number of licenses to be issued;

 

   

licenses were granted by the Directorate General of Telecommunications before March 1, 2006 and are now granted by the National Communications Commission; and

 

   

no bidding procedure is required.

We hold a license to operate all Type II services. Type II service licenses issued before November 15, 2005 are valid for ten years and may be renewed by application made two months prior to the expiration date. Type II service licenses issued or renewed on or after November 15, 2005 are valid for three years and may be renewed during the period commencing two months prior to the expiration date. There is no minimum paid-in capital requirement for Type II service providers. Our license to operate Type II services is included in our license to operate integrated services, and is valid from July 29, 2000 to July 28, 2025.

Under regulations governing the fees payable for Type II licenses, operators of simple resale or network telephone services of E.164 or non-E.164 user numbers must pay an annual license fee equal to 1% of annual revenues generated from these services during the previous year. Type II service operators providing services other than simple resale or network telephone services of E.164 or non-E.164 user numbers must pay license fees ranging from NT$6,000 to NT$150,000 depending on their respective paid-in capitals. The regulations do not apply to integrated services providers who are permitted to provide Type II services without additional Type II Licenses. The annual license fee for an integrated services provider operating Type II businesses is 1% of its annual revenues generated from its Type II services.

The Directorate General of Telecommunications started to process the applications for allocating E.164 and non-E.164 user numbers (IP phone numbers) on November 15, 2005. A few operators, including our company, have applied for IP phone numbers. We applied to the National Communications Commissions for E.164 user numbers and as of January 30, 2008, we have received approval to build a network with a capacity of 30,000 numbers. As we are governed by fixed line regulations, we need to receive approval from the National Communications Commission for our operation rules, tariff and service agreement for IP phone numbers before we can commence E.164 service.

Telecommunications Numbers

According to the Telecommunications Act, numbering codes, subscriber numbers, identification numbers and other telecommunication numbers will be distributed and managed by the National Communications Commission. These telecommunication numbers may not be used or changed without approval by the National Communications Commission. In order to maintain effective use of available telecommunication numbers, the Telecommunications Act empowers the National Communications Commission to reallocate and retrieve and to collect a usage fee for distributed telecommunication numbers. The National Communications Commission promulgated the Fee Standards for Special Telecommunication Numbers on March 18, 2010, effective immediately, requiring telecommunications service providers to pay 70% of revenues collected from the auctioning off and selection of “golden numbers” and the standard usage rates for “special identification numbers” in use.

 

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Restrictions on Dominant Telecommunications Services Providers

Under the Telecommunications Act, the regulations governing dominant telecommunications services providers apply only to Type I service providers. A Type I service provider is deemed to be dominant if it meets any of the following criteria and was declared by the Ministry of Transportation and Communications or now the National Communications Commission as dominant:

 

   

controls key basic telecommunications infrastructure;

 

   

has dominant power over market price; or

 

   

has more than a 25% market share in terms of customers or revenues.

We have been declared by the former competent authority Ministry of Transportation and Communications as a dominant Type I service provider for fixed line and mobile services.

Under the Telecommunications Act, a dominant Type I service provider must not engage in the following activities:

 

   

directly or indirectly hinder a request for interconnection with its proprietary technology by other Type I service providers;

 

   

refuse to release to other Type I service providers the calculation methods of its interconnection fees and other relevant materials;

 

   

improperly determine, maintain or change its tariffs or means of services;

 

   

reject, without due cause, a request for leasing network components by other Type I service providers;

 

   

reject, without due cause, a request for leasing lines by other service providers or customers;

 

   

reject, without due cause, a request for negotiation or testing by other service providers or customers;

 

   

reject, without due cause, a request for negotiation for co-location by other service providers;

 

   

discriminate, without due cause, against other service providers or customers; or

 

   

abuse its position as a dominant provider, or engage in other unfair competition activities as determined by the regulatory authorities.

In addition, a dominant Type I service provider is subject to special regulations limiting its tariff changes.

 

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Tariff Control and Price Cap Regulation

In order to promote competition in the telecommunications market, and as part of the government’s overall policy toward deregulation, the Telecommunications Act was amended in 1999 to abolish the former rate of return system on tariff setting in favor of price cap regulation of Type I services.

Under the Regulations Governing Tariffs of Type I Service Providers, a dominant Type I service provider must submit its proposed adjustment in primary tariffs and promotional packages to the National Communications Commission from for approval at least 14 days prior to the date of the proposed tariff changes and announce such change on media, website and business locations on the next day after the National Communications Commission grants the approval. The tariff change will come into effect seven days after the announcement.

Primary tariffs include:

 

   

for fixed line local telephone services: monthly fees, usage fees, monthly rental fees of leased lines and pay telephone usage fees;

 

   

for fixed line domestic long distance telephone services: usage fees and monthly rental fees of leased lines;

 

   

for fixed line international long distance telephone services: usage fees and leased line monthly rental fees;

 

   

for wireless services, including 3G mobile services: monthly rental fees and usage fees;

 

   

for internet services provided by dominant Type I service providers: connection and usage fees; and

 

   

other fees or tariffs announced by the Directorate General of Telecommunications before March 1, 2006 or by the National Communications Commission from March 1, 2006.

In addition, a dominant Type I service provider is required to set wholesale prices for the provision of its telecommunication services to other telecommunication enterprises. These telecommunication services and their suitable targets, all of which are subject to annual reviews by the National Communications Commission, include:

 

   

interface circuits (local and long distance) between internet access service providers and customers for Type I and Type II service providers

 

   

interface circuits (local and long distance) between internet access service providers for Type I and Type II service providers that are internet access service providers

 

   

interconnection circuits between Type I service providers and between Type I and Type II service providers of international simple resale, or ISR, and E.164 VoIP services

 

   

DSL-family (xDSL) circuits for fixed line service providers and internet service providers

 

   

other local and long distance data circuits for Type I and Type II service providers

 

   

broadband internet interconnection for Type I and Type II service providers that are internet access service providers.

 

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The initial wholesale prices set by a dominant Type I service provider may be the retail price less fees and expenses which need not be incurred, but shall not be higher than its promotional pricing. Changes in the wholesale price charged by a dominant Type I service provider may not be greater than (i) the retail price less fees and expenses which need not to be incurred but not greater than the promotional pricing; or (ii) the annual growth rate of the consumer price index in Taiwan minus the constant set by the National Communications Commission, whichever is the lower. The Regulations Governing Tariffs of Type I Service Providers further prohibits a dominant Type I service provider from practicing unfair competition against other telecommunication enterprises.

In comparison, all non-dominant Type I service providers are required to notify the National Communications Commission and the public of their proposed tariff adjustments seven days prior to the date of the proposed tariff change with respect to all tariffs. In addition, changes in tariffs charged by Type I service providers (notwithstanding the type of their respective services) may not, in any event, be greater than the annual growth rate of the consumer price index in Taiwan adjusted by a set constant, which will be periodically determined and announced by the National Communications Commission. For example, if:

 

   

the annual growth rate of the consumer price index in Taiwan minus the set constant is positive, the increased percentage of tariffs must not exceed such positive figure;

 

   

the annual growth rate of the consumer price index in Taiwan minus the set constant is negative, the decreased percentage of tariffs must be at least the absolute value of such negative figure, and the tariffs used in the given year must not be higher than the decreased tariff; and

 

   

the annual growth rate of the consumer price index in Taiwan minus the set constant equals to zero, no increase in tariffs is allowed to be made by any Type I service providers.

On January 29, 2010, the National Communications Commission announced that effective from April 1, 2010 to March 31, 2013:

 

   

the set constant to be applied to the tariff adjustment for the fixed line integrated services is 4.816% and covers the following:

 

   

dominant providers of fixed line services

 

   

tariffs of the following:

 

   

the monthly fee for ADSL leased line and the usage fee for domestic long distance telephone services (excluding public pay phones)

 

   

wholesale prices of the following:

 

   

the monthly fee for leased lines services (including local and domestic long distance leased lines) between internet service providers and their customers

 

   

the monthly fee for leased lines services (including local and domestic long distance leased lines) between an internet service provider and another internet service provider

 

   

the monthly fee for the interconnection (including local and domestic long distance lines) between a Type 1 telecommunication service provider and another Type 1 telecommunication service provider; the monthly fee for the interconnection (including local and domestic long distance lines) between a Type 1 telecommunication service provider and a Type 2 telecommunication service provider who provides simple resale and network telephone service of E.164 user numbers.

 

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the monthly fee for other local and domestic long distance leased lines

 

   

the interconnection fee for internet bandwidth interconnection

 

   

no set constant to be applied to the call charges for the domestic fixed communication services during the following periods:

 

   

the integrated services operators and the domestic telephone services operators can determine the tariff adjustment for the domestic telephone services during the specific period and seek National Communications Commission’s approval or recognition

 

   

the specific periods include 11.00pm to 8.00am from Monday to Friday, 12.00am Saturday to 8.00am Monday, and the whole day of a national holidays

 

   

the set constant to be applied to the tariff adjustment for the mobile services and the 3G mobile services is 5% and covers the following:

 

   

2G mobile service and 3G mobile service operators

 

   

tariffs of the following:

 

   

domestic short messaging services

 

   

calls made from a 2G mobile services customer or from a 3G service network to a domestic fixed communication network

 

   

calls made from a 2G mobile services customer or from a 3G service network to a 2G mobile service network, a 3G mobile service network, a 1900MHz Digital Low-Tier Cordless Telephone Services, or PHS, or WiMAX services

 

   

the set constant to be applied to the cellular voice access charge will be announced separately after the amendment to the relevant regulations.

 

   

the set constant to be applied to the tariff adjustment for other Type 1 telecommunication services is the annual growth rate of the consumer price index in Taiwan

The National Communications Commission required the service operators which are subject to the above tariff restrictions shall submit their tariff adjustment plans by March 12, 2010 to the National Communications Commission for approval. The National Communications Commission approved our tariff adjustment plan on March 24, 2010.

Type II service providers are free to establish their own tariff schemes, but are required to notify the National Communications Commission and the public upon adoption and upon any subsequent adjustments. The National Communications Commission approved our tariff adjustment plan on March 24, 2010.

 

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Regulatory Reporting Requirements

The Telecommunications Act requires that a Type I service provider, including one who concurrently offers Type II services, separately calculate the profits and losses for its different services and prohibits any cross-subsidization among services that will impede fair competition.

Interconnection Arrangements

The Telecommunications Act requires all Type I service providers to allow other Type I service providers access to their networks. It further requires Type I service providers, within three months upon request by the other Type I service provider, to reach an agreement on the relevant terms for the interconnection. Prices charged for interconnection must be based on cost. If the parties fail to reach an agreement within three months, the National Communications Commission may, either at the request of the parties or on its own accord, arbitrate and determine the interconnection terms for the parties. The Telecommunications Act authorizes the Directorate General of Telecommunications or, from March 1, 2006, the National Communications Commission to issue rules and regulations pertaining to interconnection.

When a Type I service provider leases unbundled network components to another Type I service provider, the parties are required to negotiate the rental fee. Unbundled network components include:

 

   

local loops;

 

   

local switch transmission equipment;

 

   

local trunks;

 

   

toll switch transmission equipment;

 

   

long distance trunks;

 

   

international switch transmission equipment;

 

   

network interfaces;

 

   

directory equipment and services; and

 

   

signaling network equipment.

Under the Administrative Rules for Network Interconnection, we, as a dominant telecommunication service provider for fixed line and mobile services, are required to unbundle our network and provide cost-based interconnection charges calculated with reference to the total element long-run incremental cost incurred by us. We are required to submit our proposed calculations of the total element long-run incremental cost to the National Communications Commission, for its approval each year. Local loop unbundling for both voice and data have been completed.

The Administrative Rules for Network Interconnection Between Telecommunication Service Providers was further amended by the National Communications Commission on November 2011 specifying the charges for network interconnection among Type I service providers as follow:

 

   

Before January 1, 2011, except for international communications, tariffs for communications between a mobile telecommunications network and a fixed-line network were collected from the call-originating subscribers by the call-originating service provider pursuant to the tariff schedules set by the mobile communication service provider, and revenues or any uncollectible accounts from such tariffs went to the mobile service provider. However, from January 1, 2011, although the tariffs shall still be paid by the call-originating subscribers, the tariff schedules are set by the call-originating network service provider, and revenues or any uncollectible accounts from such tariff shall go to the call-originating service provider. During the transition period from January 1, 2011 to December 31, 2016, we, as a dominant Type I fixed-line service provider, shall pay extra transition fee in addition to access charges to the mobile communications service providers.

 

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Tariffs for communications between mobile telecommunications networks shall be paid by the call-originating subscribers pursuant to the tariff schedules set by the call-originating service providers, and the revenues or any uncollectible accounts from such tariffs shall go to the call-originating service providers.

 

   

Tariffs for communications between fixed-line network will be determined by the following principles:

 

   

tariffs for communications between the local telephone networks shall be paid by the call- originating subscribers pursuant to the tariff schedules set forth by the call-originating service providers, and revenues or any uncollectible accounts from such tariffs shall go to the call-originating service providers;

 

   

tariffs schedules for the local telephone network subscribers using domestic long-distance telephone services shall be set by the domestic long-distance telephone services provider and tariffs shall be collected from the local telephone network subscribers using domestic long-distance telephone services. Revenues or any uncollectible accounts from such tariffs shall go to the domestic long-distance telephone services providers; and

 

   

tariffs schedules for the local telephone network subscribers using international long-distance telephone services shall be set by the international long-distance telephone services provider and collected from the local telephone network subscribers using international long-distance telephone services. Revenues or any uncollectible accounts from such tariffs shall go to the international long-distance telephone service providers.

 

   

Tariffs schedules for communications between satellite mobile networks and between satellite mobile networks and fixed-line communications networks or mobile communications networks shall both be set by the call-originating service providers. Revenues or any uncollectible accounts from such the tariffs shall go to the call-originating service providers.

 

   

Tariffs schedules for communications between the E. 164 VoIP networks provided by the Type I service providers and mobile telecommunications networks, or local telephone networks, or satellite mobile networks shall be set by the call-originating service providers. Revenues or any uncollectible accounts from such tariffs shall go to the call-originating service providers.

Bottleneck Facilities

Under the Telecommunications Act, when a Type I service provider cannot construct bottleneck facilities within a reasonable period of time or substitute those facilities with other available technologies, it may request for co-location on a fee basis from the owner of the facilities located at the bottleneck of the relevant telecommunications network. The owner of the facilities so requested may not reject these requests without due cause. The Ministry of Transportation and Communications had the authority, now held by the National Communications Commission, to prescribe facilities as bottleneck facilities, and has prescribed bridges, tunnels, lead-in tubes and telecommunications chambers located within buildings and horizontal and vertical telecommunications cables and lines as bottleneck facilities in relation to fixed line telecommunications networks. The National Communications Commission, in an announcement on December 21, 2006, has defined local loop facilities as the “bottleneck” of the telecommunications network and amended the Administrative Rules for Network Interconnection Between Telecommunication Service Providers in April 2007, providing that we, as a Type I service provider, can only charge other local telephone service providers at cost for local loop services. The rental tariff is derived from a cost basis and must be approved by the National Communications Commission each year.

 

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Spectrum Allocation

The National Communications Commission, previously the Ministry of Transportation and Communications, allocates all telecommunications related frequencies primarily according to the standards set by the International Telecommunications Union. The 900 MHz and 1,800 MHz frequency bands have been allocated for mobile applications. A total of 40 MHz spectrum around the 800 MHz frequency band and a total of 130 MHz of spectrum around the 2 GHz band have been allocated for 3G mobile services.

Frequency allocation for fixed wireless platforms, such as wireless local loop and local multipoint distribution services, has already been set. Only some bands of the spectrum made available for these services are completely clear and there is partial usage in all other bands. The cost of frequency usage will be based on quantity.

Provision of Universal Services

Under the Telecommunications Act, a Type I service provider may be required by the National Communications Commission, previously the Ministry of Transportation and Communications, to provide universal telecommunications services in remote or unprofitable areas. These services include voice communication services, such as public phones, and data communication services, such as internet provision for libraries and public primary and secondary schools. All Type I service providers and certain Type II service providers designated by the National Communications Commission, previously the Ministry of Transportation and Communications, will be required to contribute a fixed portion of their annual revenues to a universal services fund. Such a fund will be used to compensate for any losses, bad debts and management fees incurred by the relevant Type I service provider in providing the universal services. All providers of universal services cannot refuse any request for service, unless for legitimate reasons, and cannot charge more than the predetermined tariffs.

Equal Access

As a result of the liberalization of Taiwan’s telecommunications industry, a Type I service provider, including a 3G mobile services provider and a WiMax service operator, is required to provide its customers with equal access to the domestic and international long distance telephone services provided by other service providers. A Type I service provider may provide equal access through pre-selection or call-by-call selection. Before July 1, 2005, all Type I service providers, including us, provide equal access only through call-by-call selection. When a customer makes a call using call-by-call selection, such customer has the option to select a service provider by dialing the network identification prefix assigned to the service provider of his choice. This will result in the automatic selection of the preferred service provider for the provision of relevant telecommunication services. Starting from July 1, 2005, all Type I service providers also provide equal access through pre-selection in Keelung City, Taipei City/ County, Taichung City/County and Kaohsiung City/County. Equal access through pre-selection is available throughout Taiwan since January 1, 2006. The pre-selection function allows any customer to select in advance a long distance or international service provider of his or her choice. When such customer makes a call using this function, the communications network will automatically interconnect to the long distance or international network previously selected by such customer.

Number Portability

According to the Telecommunications Act and the Administration Rules Governing Number Portability, Type I service providers shall provide number portability service which enables customers to retain their existing local and toll free fixed line telephone numbers or mobile phone numbers when they switch from the original Type I service provider to other Type I service provider. Meanwhile, Type I service providers shall mutually grant each other number portability services on a reciprocal basis, and shall conform in accordance with the principle of impartiality and reasonableness, and shall not be discriminatory.

 

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Under the regulation, we are required to provide number portability service for fixed line customers in Taipei City, New Taipei City, Keelung City, Taichung City, Kaohsiung City and other areas where there are two or above fixed line service providers. We have also provided number portability service for mobile communication customers since October 15, 2005. Pursuant to the regulation, we shall compile and submit related information of number portability for the previous six months to NCC by January 10 and July 10 of each year.

Local Loop Unbundling

In December 2006, the National Communications Commission defined the local loop as facilities “at the bottleneck of telecommunications networks” in accordance with the Regulations Governing Fixed Network Telecommunications Businesses. The National Communications Commission requires us to unbundle the local loops and allow other telecommunications operators to use these connections. The local loop or last mile connections are the physical wire connections between the telephone exchange’s central office to the customer’s premises usually owned by the incumbent telephone company. The National Communications Commission further amended the “Administrative Rules for Network Interconnection between Telecommunication Service Providers” in April 2007 which provides that we can only charge other local telephone service providers at cost for local loop services instead of on the basis of commercial negotiations.

Co-location

We have been declared by the former competent authority Ministry of Transportation and Communications as a dominant Type I service provider for fixed line and mobile services. According to the Telecommunication Act, the Regulations Governing Fixed Network Telecommunications Businesses and the Administrative Rules for Network Interconnection Between Telecommunication Service Providers, if any other service provider requests for co-location, we must negotiate with them, unless otherwise provided by laws or regulations. As of the end of 2010, we are currently co-locating 29 POI sites and two cable stations with other Type I fixed line service providers and 13 POI sites with other Type I mobile service providers.

Ownership Limitations

The laws of the Republic of China limit foreign ownership of our common shares. Prior to March 1, 2006, the Ministry of Transportation and Communications, as the competent authority under the Telecommunications Act, had the power to prescribe the limits on foreign ownership of our common shares. After the formation of the National Communications Commission on March 1, 2006, the National Communications Commission replaced the Ministry of Transportation and Communications as the competent authority under the Telecommunications Act pursuant to the Organization Law. On July 18, 2006, the Ministry of Transportation and Communications and the National Communications Commission reached an agreement where the Ministry of Transportation and Communications will have the authority to adjust foreign ownership limits only after negotiations with the National Communications Commission. On June 14, 2007, we applied to both the National Communications Commission and the Ministry of Transportation and Communications, asking for an increase in the limitation of direct and indirect foreign ownership of our common shares. After consultation with the National Communications Commission, the Ministry of Transportation and Communications increased our foreign ownership limitation of and total direct and indirect shareholdings from 49% to 55%. Our foreign ownership limitation of total direct shareholdings remained at 49%.

Under the current Telecommunications Act, the Chairman of a Type I service provider is required to be a citizen of the Republic of China.

 

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Administrative Fee Law

According to the Administrative Fee Law, central and local governments, government agencies and schools are empowered to collect administrative fees from us and other telecommunications services providers for the telecommunications facilities built on public roads and properties. Under the Administrative Fee Law, Urban Road Act and Local Road Act, road authorities of municipal governments may collect usage fees from users of local roads, including us, for establishing lines along with the local roads. The fee schedule is set up in the Standard for Usage Fees of Local Roads.

Under the Public Road Law, administrative authorities of public roads may collect usage fees from the users of public roads. According to the Rules Governing Collection of Usage Fees on Public Roads, the relevant collection agencies, including agencies designated by the Ministry of Transportation and Communications and municipal governments, depending on the types of public roads, may collect usage fees from users, including us, for establishing lines along with the public roads.

The members of the Transportation Committee in the Legislative Yuan are currently reviewing an amendment to Article 72 of the Public Road Law that seeks to reduce state compensation and improve the government’s image. Clauses amended include stipulations that manhole covers need to be level with the road after repairs, with the difference in road surface heights within a three meter radius to be no more than 0.6 centimeters. The amendment is currently under secondary review in the Legislative Yuan and passage of the amendment may raise our maintenance costs in the future.

Personal Data Protection

Under the Computer-Processed Personal Data Protection Act, or CPPDPA, every entity regulated by the CPPDPA, such as government agencies or departments, credit investigation companies, hospitals, telecommunications companies and financial institutions shall register with the relevant regulatory authorities and obtain a license pursuant to the CPPDPA for collecting, processing by computer or transmitting internationally and using personal data. In addition, before the collection or process by computers of individual’s personal data, we, as one of the regulated entity, are also required to obtain such individual’s prior written consent or have contractual or quasi-contractual relationship with such individual.

The CPPDPA requires that personal data shall be collected or used with due respect for the rights and interests of the data subject in an honest and credible manner which does not overstep the necessary scope of registered specific purposes. If an individual suffers any monetary or non-monetary losses due to a regulated entity’s violation of the CPPDPA, the amount of damages that can be claimed by such individual is up to NT$100,000 unless such individual could prove that his/her losses are higher than that amount. The ceiling of the aggregate amount of damages payable by a violator for a single violation is NT$20 million regardless of how many persons have suffered such losses. In addition, the violator will be subject to an administrative fine of NT$20,000 to NT$100,000. Serious violation could cause the regulated entity’s license obtained pursuant to the CPPDPA being cancelled.

The CPPDA has been largely amended and renamed as the Personal Data Protection Law on May 26, 2010. Under the Personal Data Protection Law, which may become fully effective by the end of 2011, the major amendments include: (i) extension of protection area: protection area has been extended to all personal data (not only limited to computer-processed personal data, hard copy personal information such as written or hand-copied material is also included); and (ii) more serious punishment for civil claims, criminal offenses and administrative liabilities: the ceiling of the aggregate compensation amount for damages payable in a single case has increased to NT$200 million; the defendant may be subject to an imprisonment of up to five years; and the ceiling of the penalty for administrative liabilities has also increased to NT$500,000.

The newly amended Personal Data Protection Law may increase our potential liability for failing to protect the personal data of our customers. We will review and improve our management in the protection of the personal data of our customers, and enhance the education of our employees to better protect the interest of our customers.

 

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Statute of Chunghwa Telecom Co., Ltd.

The Executive Yuan, on February 26, 2008, proposed a motion for the abolishment of the Statute of Chunghwa Telecom Co., Ltd. for legislative approval. We cannot determine when this motion will be approved by the Legislative Yuan. Under Republic of China law, the Statute of Chunghwa Telecom Co., Ltd will continue in effect until the Legislative Yuan formally approves the motion and the President of the Republic of China pronounces the abolishment of the law.

Approval of Ministry of Transportation and Communications

While the continued application of the Statute of Chunghwa Telecom Co., Ltd. remains unclear and it may be abolished in the near future, under that statute we are required to obtain approval of the Ministry of Transportation and Communications for:

 

   

the adoption of and any changes to our articles of incorporation and board of directors organization rules;

 

   

any changes to our authorized capital and any issuance of our common shares;

 

   

any changes to primary tariffs for Type I services; and

 

   

any changes to operational procedures of Type I services.

Employee Subscription Rights for New Issues of Our Common Shares

In accordance with the Statute of Chunghwa Telecom Co., Ltd., our employees have rights to subscribe for not more than 10% of a new issuance of our common shares in accordance with subscription rules which were to be announced by the Ministry of Transportation and Communications. However, no such rules were ever announced. In addition, under the Republic of China Company Law, unless exempted by the relevant government authorities, a Republic of China company must give its employees pre-emptive rights to subscribe for between 10-15% of any new issue of shares by us.

C. Organizational Structure

Set forth below is a diagram indicating our organization structure as of March 31, 2011.

 

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LOGO

D. Property, Plant and Equipment

Please refer to “—B. Business Overview” for a discussion of our property, plant and equipment.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

You should read the following discussion of our financial condition and results of operations together with the consolidated financial statements and the notes to such statements included in this annual report.

For the convenience of readers, NT dollar amounts used in this section for, and as of, the year ended December 31, 2010 have been translated into U.S. dollar amounts using US$1.00=NT$29.14, set forth in the statistical release of the Federal Reserve Board on December 30, 2010. The U.S. dollar translation appears in parentheses next to the relevant NT dollar amount.

 

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Overview

A number of recent and expected future developments have had, and in the future may have, a material impact on our financial condition and results of operations. These developments include:

 

   

changes in our revenue composition and sources of revenue growth;

 

   

increased competition in the fixed line, leased line and mobile services markets;

 

   

tariff adjustments;

 

   

capital expenditures as a result of technological improvements and changes in our business;

 

   

provisions for pension payments and other stock-based compensations to our employees; and

 

   

taxation.

Each of these developments is discussed below.

Changes in our revenue composition and sources of revenue growth

Our domestic fixed communications business revenues are derived primarily from the provision of local, domestic long distance, broadband access, leased line service, MOD, domestic data services and domestic other services including information and communication technologies, corporate solution services, billing handling services and the leasing of real estate properties. In addition, we also derive fixed line revenues from providing interconnection services to other carriers. Our revenues from mobile communications business are principally derived from the provision of mobile services, paging services, sales of mobile handsets and data cards and mobile other services. Our revenues from internet business are generated principally from HiNet internet service, internet VAS, data communication services, internet data center, and internet other services including government services and corporate solution services. Our revenues from international fixed communications business derived primarily from international long distance, international leased line, international data services, satellite services, and international other services. Our other revenues are principally derived from non-telecom services.

The table below sets forth the revenues from our principal lines of business as a percentage of total revenues for the periods indicated.

 

     Year ended December 31,  
     2008     2009     2010  

Revenues:

      

Domestic fixed communications business

     36.2     36.0     34.9

Mobile communications business

     44.0        43.6        44.0   

Internet business

     11.4        11.9        12.1   

International fixed communications business

     7.9        7.7        7.7   

Others

     0.4        0.7        1.3   
                        

Total

     100.0     100.0     100.0
                        

Over the past three years, the composition of our revenue base has undergone a change as a result of our strategy to diversify our revenues and focus on generating increased revenues from higher growth businesses, such as internet business.

Our domestic fixed communications business has been an important source of revenues over the last three years. We derive domestic fixed communications from the provision of ADSL and FTTx access services that provides customers with data access lines. Increasing internet penetration in Taiwan and higher data traffic have contributed to a significant increase in our revenues from domestic fixed communications services in recent years. The percentage of revenues from domestic fixed communications within total revenues decreased in 2010 compared to 2009. It was mainly due to the greater decreases in domestic long distance calls because of mobile services substitution and the mandatory tariff reduction imposed by the National Communications Commission and the decline in local call service revenue. However, we believe that domestic fixed communications business will continue to generate a significant portion of our revenues.

 

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Revenues from our mobile communications business made a major contribution to our revenues over the last three years. While competition with other mobile service providers and the mandated tariff reduction by NCC have caused a decline in revenues, we have experienced a significant increase in revenues generated by our mobile value-added services due to increased smart phone and mobile internet use by our subscribers. As a result, we believe that our mobile communications business will continue to generate a significant portion of our revenues.

Our internet business was another important source of revenues over the last three years. We derived internet business revenues from the provision of HiNet internet service and internet value-added services. The percentage of revenues from internet services within total revenues increased in 2010 compared to 2009, mainly due to the growth of our HiNet ISP service and internet VAS. We believe that internet business will continue to generate a growing portion of our revenues.

Our international fixed communications business was also an important source of our revenues over the last three years. We derived our international fixed communications revenues mainly from international long distance telephone services, international leased line services and international data services. The revenues from our international fixed communications business as a percentage of our total revenues remained constant from 2009 to 2010, primarily because the growth rate of international leased line and international data services was similar to that of our total revenues. We believe that our international fixed communications business will continue to contribute to our revenues.

Tariff adjustments

We adjust our tariffs and offer promotional packages from time to time primarily in response to market conditions. We also from time to time are required to adjust our pricing in line with domestic regulations.

The National Communications Commission passed a resolution on December 21, 2006 adopting a price reduction plan requiring the continuous reduction in telecommunication tariffs over three years. Minimum reductions of 4.88% for fixed line to mobile call tariffs, 4.88% for the tariffs of our highest monthly rate plan, 4.88% for mobile prepaid calling card tariffs and 5.35% for ADSL tariffs must be made each year. The price reduction plan also required us to stop collecting a NT$5.0 monthly maintenance fee from our fixed line customers who have paid at least 20 years worth of tariffs and those who chose self-maintenance customers starting January 1, 2008 and a NT$70.0 fixed line basic charge from our ADSL customers who only use data services. On January 29, 2010, the National Communications Commission announced a new tariff reduction plan starting on April 1, 2010 to March 31, 2013. The percentage of decrease set by National Communications Commission was DCPI- 4.816% for IP Peering fees, domestic leased-line fees, ADSL access fees and long distance tariffs, and DCPI- 5.00% for fees for mobile calls to local fixed lines and other networks and domestic mobile SMS, where DCPI is the year-over-year change of the consumer price index of previous year released by the Directorate-General of Budget, Accounting and Statistics of the Executive Yuan. DCPI for 2009 that is used for the tariff reduction starting from April 1, 2010 is -0.87% ; DCPI for 2010 that is used for the tariff reduction starting from April 1, 2011 is 0.96%.

We expect to continue to adjust tariffs and offer a variety of promotional packages from time to time in response to increasing competition and in order to take advantage of our pricing power from economies of scale. We may also be required to adjust our pricing due to changes in domestic regulations.

Capital expenditures as a result of technological improvements and changes in our business

In recent years, we have focused on modernizing and upgrading our mobile services network and on developing our FTTx network, which enables transmission of digital information at a high bandwidth over fiber loops. In particular, we have enhanced our telecommunications services through:

 

   

the introduction of a IP-based exchange system in our long distance telephone network;

 

   

the implementation of a network modernization program, including a gradual transfer from our public switched telephone network to a system based on internet protocol, to remain at the forefront of new technologies;

 

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the deployment of an intelligent NGN network for fixed line and multimedia services;

 

   

the development and deployment of Green IDC for meeting the new demands of cloud computing services;

 

   

the deployment of a high-capacity long-haul reconfigurable optical add drop multiplexing system and a nationwide internet protocol backbone network with hundreds of Gbps gigabit switching routers for internet and managed IP services; and

 

   

the expansion and upgrade of our mobile services network as well as WiFi/Femtocell to improve indoor 3G mobile network coverage and transmission speed for mobile internet.

As a result, we made aggregate capital expenditures of NT$133.0 billion over the period from January 1, 2006 to December 31, 2010.

Our long-term goal is to optimize our capital expenditures by focusing on investing in innovative products and services with attractive return profiles. We evaluate our investment opportunities by benchmarking them against internal return requirements. We are currently finalizing plans for the gradual upgrade of our entire public switched telephone network to a next-generation network. Next-generation internet protocol switches will have substantially more capacity and greater upgrade flexibility and should result in increased operational efficiencies from reduced switching centers and related property, materials and personnel costs. We have also devoted resources toward the effective upgrade of our 3G mobile network to 3.5G and HSPA+ and the continuing build-out of our FTTx infrastructure. In addition, we are planning to deploy green Internet Data Centers and service delivery network for the innovative services, such as cloud computing, fixed mobile convergence services and four-screen digital convergence services.

Provisions for pension payments to our employees

Personnel expenses constitute a significant portion of our operating costs and expenses. In 2008, 2009 and 2010, personnel expenses represented 28.6%, 29.4% and 30.4% of our total operating costs and expenses, respectively, and pension costs represented 2.0%, 1.9% and 2.0% of our total operating costs and expenses, respectively. The table below sets forth information regarding our personnel expenses and as a percentage of our total operating costs and expenses for the periods indicated.

 

     For the year ended December 31,  
     2008     2009     2010  
     (in billions of NT$, except percentages)  

Personnel expenses:

               

Salaries

     22.1         15.5     22.4         15.8     22.9         15.8

Insurance

     1.6         1.1        1.8         1.3        1.9         1.3   

Pension

     2.9         2.0        2.7         1.9        2.9         2.0   

Other

     14.3         10.0        14.8         10.4        16.4         11.3   
                                                   

Total personnel expenses

     40.9         28.6     41.7         29.4     44.1         30.4
                                                   

Total operating costs and expenses

     143.1         100.0     142.0         100.0     145.0         100.0

At the time of our privatization, our then existing defined benefit pension obligations were settled in full. After completion of our privatization, our continuing employees were deemed to have commenced employment as of the date our privatization was completed for seniority purposes under our pension plans in effect after privatization. Under applicable Republic of China regulations, upon our privatization, the Ministry of Transportation and Communications assumed the obligation to make annuity payments to our employees who retired before our privatization.

Taxation

In May 2009, the Legislative Yuan passed an amendment to Article 5 of the Income Tax Law, which reduces the income tax rate of profit-seeking enterprises from 25% to 20% effective in 2010. Furthermore, in May 2010, the Legislative Yuan passed the amendment of Article 5 of the Income Tax Law, which reduced the income tax rate of profit-seeking enterprises from 20% to 17%, effective on January 1, 2010. We benefit from tax incentives generally available to technology companies in the Republic of China, including tax credits of up to 30% of the amount of some of our research and development, automation and employee training expenditures in accordance with the Statute for Upgrading Industries. We also qualify for tax benefits at a rate of 5% to 15% of our investment amount for qualified equipment and technology. However, due to the expiration of the Statute for Upgrading Industries at the end of 2009, we will no longer receive tax credits for new investments in automation, employee training expenditures incurred, and equipment and technology purchased after January 2010. In addition, tax credit rate for research and development expenditures incurred after January 1, 2010 has been reduced to 15% from 30%, under the Statute for Innovating Industries enacted on May 12, 2010. As a result, though our effective tax rate was 23.3%, 22.3% and 15.8% in 2008, 2009 and 2010, respectively, the smaller scope of tax credits and lower tax credit rate will reduce the tax credits amount that we could benefit from in the future. Therefore, we expect that our effective tax rate in the future will not be lower compared to that of 2010.

 

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In 1997, the Income Tax Law of the Republic of China was amended to integrate corporate income tax and stockholder dividend tax to eliminate the double taxation effect for resident stockholders of Taiwan companies. Under the amendment, all retained earnings generated from January 1, 1998 and not distributed to stockholders as dividends in the following year are assessed with a 10% retained earnings tax. See “Item 10. Additional Information—E. Taxation—Republic of China Taxation—Dividends.” This has not had an impact on our financial results of operations because of our high dividend payout policy.

Critical Accounting Policies

Summarized below are our accounting policies that we believe are both important to the portrayal of our financial results and involve the need for management to make estimates about the effect of matters that are uncertain in nature. Actual results may differ from these estimates, judgments and assumptions. Certain accounting policies are particularly critical because of their significance to our reported financial results and the possibility that future events may differ significantly from the conditions and assumptions underlying the estimates used and judgments made by our management in preparing our financial statements. The following discussion should be read in conjunction with the consolidated financial statements and related notes, which are included in this annual report.

Revenue Recognition

We recognize revenues when we have persuasive evidence of an arrangement, the goods have been delivered or the services have been rendered to the customer, the sales price is fixed or determinable and collectability is reasonably assured. We measure revenues at the fair value of the consideration received or receivable and represents amounts agreed between us and the customers for goods sold in the normal course of business, net of sales discounts and volume rebates. The costs of providing services are recognized as incurred.

Usage revenues from fixed-line services (including local, domestic long distance and international long distance), cellular services, Internet and data services and interconnection and call transfer fees from other telecommunications companies and carriers are billed in arrears and are recognized based upon minutes of traffic processed when the services are provided in accordance with contract terms.

We recognize other revenues as follows: (i) one-time subscriber connection fees (on fixed-line services) are deferred and recognized over the average expected customer service periods, (ii) monthly fees (on fixed-line services, wireless and Internet and data services) are accrued every month, and (iii) prepaid services (fixed line, cellular and Internet) are recognized as income based upon actual usage by customers or when the right to use those services expires. Where we enter into transactions which involve both the provision of air time bundled with products such as 3G data card and handset, total consideration received from handsets in these arrangements is allocated and measured using units of accounting within the arrangement based on relative fair values limited to the amount that is not contingent upon the delivery of other items or services. Relative fair values are based on the selling prices of 3G data cards and handsets sold on a standalone basis and the monthly fees on the subscription contracts.

 

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Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses that result from the inability of our customers to make required payments. We base our allowances on the likelihood of recoverability of accounts receivable by operating segment based on past experience and current collection trends that we expect to continue. Our evaluation also includes the length of time the receivables are past due, geographic concentrations and the general business environment. If changes in these factors occur, or the historical data we use to calculate the allowance provided for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and our future results of operations could be materially and adversely affected. Even as revenues have increased in recent years, the allowance for doubtful accounts has decreased due to stricter credit investigations for new customers and more efficient collection activities for outstanding accounts.

Estimated Useful Lives of Long-Lived Assets

A significant portion of our total assets consists of long-lived assets, primarily property, plant and equipment and definite-lived intangibles. We estimate the useful lives of property, plant and equipment and other long-lived assets with finite lives in order to determine the period of time over which depreciation and amortization expense should be recorded. The useful lives are estimated at the time assets are acquired and are based on historical experience with similar assets as well as the anticipated technological evolution or other environmental changes. If technological changes were to occur more rapidly than anticipated or in a different form than anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation and amortization in the relevant periods. Alternatively, technological obsolescence could result in a write-down in the value of the assets to reflect impairment. We review these types of assets for impairment quarterly, or when events or circumstances indicate that the carrying amount may not be recoverable over the remaining life of an asset. In assessing impairments, we use estimated cash flows that take into account management’s estimates of future operations. We did not have significant impairment losses of long-lived assets in 2008 and 2009, but had NT$66 million (US$2.3 million) impairment loss in 2010.

Investments in Unconsolidated Companies

We hold investments in other companies that we account for under the equity method or cost method of accounting, depending on our ability to exert significant influence over the investee company. The amounts for our equity method investments generally represent our cost of the initial investment adjusted for our share of the investee company’s income or loss and any dividends received. The amounts for our investments carried at cost where the securities are not publicly traded generally represent our cost of the initial investment less any adjustments we make when we determine that an investment’s net realizable value is less than its carrying cost. Estimating the net realizable value of investments in privately held companies can be inherently subjective and may contribute to significant volatility in our reported results of operations.

We assess the impairment of investments accounted for using the equity method whenever triggering events or changes in circumstances indicate that an investment may be impaired and carrying value may not be recoverable. We measure the impairment based on the projected future cash flow of the investees, the underlying assumptions for which had been formulated by such investees’ internal management team, taking into account sales growth and capacity utilization.

The process of assessing whether a particular cost method investment’s net realizable value is less than its carrying cost requires a significant amount of judgment. We periodically evaluate these long-term investments based on quoted market prices, if available, the financial condition of the investee company, economic conditions in the industry and our intent and ability to hold the investment for a long period of time. If quoted market prices are not available, we estimate the fair value using the net asset values as well as the financial condition of the investee company. This information may be based on information that we request from the investee companies and may not be subject to the same disclosure and audit requirements as required of U.S. companies, and as such, the reliability and accuracy of the information may vary. If we deem the fair value of an investment to be less than the book value based on the above factors, and the decline in value is deemed to be other than temporary, we record the difference as impairment in the period of occurrence. In 2008, we recognized impairment losses of NT$15 million for PRTI International and NT$10 million for Essence Technology Solution due to adverse changes in the market. In 2009, we recognized impairment losses of NT$10 million for Essence Technology Solution and NT$10 million for Digimax Inc. due to poor operating performance. In 2010, we recognized impairment losses of NT$21 million (US$0.7 million) for Digimax Inc., NT$13 million (US$0.4 million) for ChipSip Technology Co., Ltd. due to poor operating performance, NT$9 million (US$0.3 million) for Crystal Media Inc. and NT$16 million (US$0.5 million) for A2peak Power Co., Ltd. due to adverse changes in market conditions.

 

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Valuation of long-lived assets, intangible assets

We assess the impairment of long-lived assets and intangible assets whenever triggering events or changes in circumstances indicate that the asset may be impaired and carrying value may not be recoverable. Indications we consider important which could trigger an impairment review include, but are not limited to, the following:

 

   

External sources of information:

 

   

during the period, an asset’s market value has declined significantly more than would be expected as a result of the passage of time or normal use.

 

   

significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.

 

   

market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially.

 

   

the carrying amount of the net assets of the entity is more than its market capitalization.

 

   

Internal sources of information:

 

   

evidence is available of obsolescence or physical damage of an asset.

 

   

significant changes with an adverse effect on the entity have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used.

 

   

evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected.

When an indication of impairment is identified for intangible assets other than goodwill, any excess of the carrying amount of an asset over its recoverable amount is recognized as a loss. If the recoverable amount increases in a subsequent period, the amount previously recognized as impairment would be reversed and recognized as a gain. However, the adjusted amount may not exceed the carrying amount that would have been determined, as if no impairment loss had been recognized.

Goodwill represents the excess of the consideration paid for business acquisition over the fair value of identifiable net assets acquired. Goodwill is tested for impairment annually. If an event occurs or circumstances change which indicates that the fair value of goodwill is below its carrying amount, an impairment loss is recognized. A subsequent reversal of such impairment loss is not allowed.

Pension Benefits

The amounts recognized in our consolidated financial statements related to pension benefits are determined on an actuarial basis that utilizes several different assumptions in the calculation of such amounts. Significant assumptions used in determining our pension benefits are the discount rate, the expected long-term rate of return on plan assets, the rate of increase in compensation levels, and the average remaining years of service for employees.

 

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We use long-term historical actual return information and estimate future long-term investment returns by reference to external sources to develop the expected long-term return on plan assets. The discount rate is assumed based on the rates available on high-quality fixed-income debt instruments with the same period to maturity as the estimated period to maturity of the pension benefit. We assume the rate of increase in compensation levels and average remaining years of service based on historical data. Any changes in one or more of these assumptions could impact our pension benefits.

Accounting for Income Taxes

Deferred income taxes represent the effect of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for income tax purposes. We measure deferred tax assets and liabilities using statutory tax rates that, if changed, would result in either an increase or a decrease in the provision for income taxes in the period of change.

We record a valuation allowance to reduce our deferred tax assets to the amount of future tax benefit that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, we cannot assure you that we would not need to increase the valuation allowance to cover additional deferred tax assets that may not be realizable. Any increase in the valuation allowance could have a material adverse effect on our income tax provision and net income in the period in which such determination is made.

We had a valuation allowance of NT$268 million (US$9.2 million) on our deferred tax asset balance as of December 31, 2010. We do not have a full valuation allowance on the deferred tax asset, as we believe these benefits will be fully realizable based on our projection of future operating income. If we experience a significant decrease in our future operating income, our ability to realize the deferred tax assets could be negatively impacted, and thus an increase in the valuation allowance might be required.

Any tax credits arising from purchases of machinery, equipment and technology, research and development expenditures, personnel training, and investments in important technology based enterprises are recognized using the flow through method. Adjustments of prior years’ tax liabilities are added to or deducted from the current year’s tax provision. Under R.O.C. GAAP, income taxes of 10% on undistributed earnings are recorded in the year of stockholders approval which is the year subsequent to the year the earnings are generated. Under US GAAP, the 10% tax on unappropriated earnings is accrued during the period the earnings arise and adjusted to the extent that distributions are approved by the stockholders in the following year.

Effective from January 1, 2007, we adopted a guidance prescribing the recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return under U.S. GAAP. This guidance also provides guidance on derecognition, classification, interest and penalties, disclosure and transition. The evaluation of a tax position in accordance with this guidance is a two step process. The first step is recognition, where we evaluate whether an individual tax position has a likelihood of greater than 50% of being sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation processes. For tax positions that are currently estimated to have a less than 50% likelihood of being sustained, zero tax benefit is recorded. For tax positions that have met the recognition threshold in the first step, we perform the second step of measuring the benefit to be recorded. The actual benefits ultimately realized may differ from the estimates. The adoption of this guidance did not have a material impact on our report. We did not identify significant unrecognized tax benefits for the year ended December 31, 2008, 2009 and 2010. It is highly unlikely that we will incur any interests or penalties related to potential underpaid income tax expenses.

 

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Our Financial Reporting Obligations

Our ongoing financial reporting in our Form 20-F annual reports and interim financial reporting furnished to the SEC on Form 6-K had been based on U.S. GAAP through fiscal year 2007. Beginning with our first quarter interim financial report furnished on Form 6-K and our Form 20-F annual report for fiscal year 2008, we prepared our financial statements under R.O.C. GAAP, with reconciliations to U.S. GAAP.

A. Operating Results

The following table sets forth our revenues, operating costs and expenses, income from operations and other financial data for the periods indicated.

 

     For the year ended December 31,  
     2008      2009      2010  
     NT$      NT$      NT$      US$  
     (in billions)  

Revenues:

           

Domestic fixed communications

     73.1         71.5         70.7         2.4   

Mobile communications

     88.8         86.5         89.0         3.1   

Internet

     23.0         23.7         24.5         0.8   

International fixed communications

     15.9         15.2         15.5         0.5   

Others

     0.8         1.5         2.7         0.1   
                                   

Net revenues

     201.7         198.4         202.4         6.9   

Operating costs and expenses:

           

Operating costs

     113.5         112.7         115.3         3.9   

Operating expenses:

           

Marketing

     22.7         22.3         22.5         0.8   

General and administrative

     3.7         3.8         4.0         0.1   

Research and development

     3.2         3.2         3.2         0.1   
                                   

Total operating costs and expenses

     143.1         142.0         145.0         4.9   

Income from operations

     58.6         56.4         57.4         2.0   

Other income, net

     1.1         0.8         0.3         —     
                                   

Income before income tax expense

     59.7         57.2         57.7         2.0   

Income tax expense

     13.9         12.7         9.1         0.3   
                                   

Consolidated net income

     45.8         44.5         48.6         1.7   
                                   

Attributable to:

           

Stockholders of the parent

     45.0         43.8         47.6         1.6   

Minority interests

     0.8         0.7         1.0         0.1   

The following table sets forth our revenues, operating costs and expenses, income from operations and other financial data as a percentage of our total revenues for the periods indicated.

 

     For the year ended December 31,  
     2008     2009     2010  
     (as percentages of total revenues)  

Revenues:

      

Domestic fixed communications

     36.2     36.0     34.9

Mobile communications

     44.0        43.6        44.0   

Internet

     11.4        11.9        12.1   

International fixed communications

     7.9        7.7        7.7   

Others

     0.4        0.7        1.3   
                        

Total revenues

     100.0     100.0     100.0
                        

Operating costs and expenses:

      

Operating costs

     56.3     56.8     57.0

Operating expenses:

      

Marketing

     11.3        11.2        11.1   

General and administrative

     1.8        1.9        2.0   

Research and development

     1.6        1.6        1.6   
                        

Total operating costs and expenses

     71.0        71.5        71.7   

 

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     For the year ended December 31,  
     2008     2009     2010  
     (as percentages of total revenues)  

Income from operations

     29.0        28.5        28.3   

Other income, net

     0.5        0.4        0.2   
                        

Income before income tax expense

     29.5        28.9        28.5   

Income tax expense

     6.9        6.4        4.5   
                        

Consolidated net income

     22.6     22.5     24.0
                        

Attributable to:

      

Stockholders of the parent

     22.3        22.1        23.5   

Minority interests

     0.3        0.4        0.5   

Each of our operating segments is managed separately because each represents a strategic business unit that serves a different market. We measure our segment performances mainly based on revenues and income before tax.

The year ended December 31, 2010 compared with the year ended December 31, 2009

Revenues

Our revenues increased by 2.1% from NT$198.4 billion in 2009 to NT$202.4 billion (US$6.9 billion) in 2010. This increase was primarily due to increase in revenues generated from mobile communications, internet, international fixed communications and other business sectors.

Domestic fixed communications

Domestic fixed communications revenues comprised 36.0% and 34.9% of our revenues in 2009 and 2010, respectively. Our domestic fixed line revenues decreased by 1.1% from NT$71.5 billion in 2009 to NT$70.7 billion (US$2.4 billion) in 2010.

Local telephone services. Our local telephone revenues decreased from NT$33.2 billion in 2009 to NT$32.3 billion (US$1.1 billion) in 2010. This reflects a 6.4% decline in traffic volume from 14.6 billion minutes in 2009 to 13.7 billion minutes in 2010, offset by a 0.5% increase in average local usage fees. The decline in traffic volume was primarily due to the traffic migration from fixed line services to mobile and Internet telephone services. We expect this trend to continue as broadband and mobile services become more widely adopted in Taiwan. However, we believe the rate of such migration is slowing down. Our local interconnection revenues decreased by NT$77 million (US$2.6 million) from 2009 to 2010 because of the decrease in fixed line to mobile voice traffic volume of calls terminating on mobile networks of alternative operators.

Domestic long distance telephone services. Our domestic long distance telephone revenues decreased by 10.2% from NT$7.4 billion in 2009 to NT$6.6 billion (US$0.2 billion) in 2010. This decrease was mainly due to a decrease in traffic volume from 3.6 billion minutes in 2009 to 3.4 billion minutes in 2010 and domestic long distance interconnection tariff decreases mandated by the National Communications Commission. The decrease in traffic volume was primarily due to the continued traffic migration from fixed line services to mobile services and VoIP. Our interconnection revenues also decreased primarily because the telecommunications operators construct their own interconnection circuit.

Broadband access. The number of our ADSL customers decreased from 2.7 million in 2009 to 2.3 million in 2010 due to customer migration to our FTTx services. There was an increase in the number of FTTx customers from approximately 1.6 million in 2009 to approximately 2.0 million in 2010. Broadband access revenue increased from NT19.9 billion for 2009 to NT$20.3 billion (US$0.7 billion) for 2010.

Domestic leased line. While demand for higher speed leased lines continues to increase, our overall leased line tariffs have continued to be adversely affected by competition from other fixed line operators, as well as the continued migration of domestic leased line customers to broadband services. Domestic leased line revenue decreased from NT$6.7 billion for 2009 to NT$6.1 billion (US$0.2 billion) for 2010.

 

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MOD. Our MOD revenues increased by 9.9% from NT$0.9 billion in 2009 to NT$1.1 billion (US$37.5 million) in 2010. This increase was mainly due to an increase in the average revenue per user. In addition, since 2010, MOD revenues include billing fees and advertising revenues, which was previously accounted for under domestic other services.

Mobile communications

Revenues from our mobile communications business segment comprised 43.6% and 44.0% of our revenues in 2009 and 2010, respectively. Revenues from our mobile communications business segment increased by 2.9% from NT$86.5 billion in 2009 to NT$89.0 billion (US$3.1 billion) in 2010. This increase was principally due to the growth of mobile VAS revenue and handset sales revenue offsetting the decline of mobile voice revenue over years. The growth of mobile voice traffic due to the general recovery of the economy in the ROC partially offset the impact from the mandatory tariff reduction, which helped slow down the decline of the mobile voice revenue in 2010.

Mobile services. Revenues from our mobile services comprised 36.0% and 36.1% of our revenues in 2009 and 2010, respectively. Revenues from our mobile services increased by 2.3% from NT$71.4 billion in 2009 to NT$73.1 billion (US$2.5 billion) in 2010 due to the growth of mobile VAS revenue from NT$8.4 billion in 2009 to NT$ 11.1 billion (US$0.38 billion) in 2010, offsetting the decline of mobile voice revenue. The growth of mobile traffic volume due to the general recovery of the economy in the ROC also helped slow down the decline in mobile voice revenue.

Sales of mobile handsets and data cards. Revenues from our sales of mobile handsets and data cards comprised 7.6% and 7.9% of our revenues in 2009 and 2010, respectively. Revenues from our sales of mobile handsets and data cards increased by 6.1% from NT$15.0 billion in 2009 to NT$15.9 billion (US$0.6 billion) in 2010. This increase was principally due to the strong sales of mobile smart phones and the general recovery of the economy in the ROC.

Internet

Internet revenues comprised 11.9% and 12.1% of our revenues in 2009 and 2010, respectively. Our revenues attributable to our internet business increased by 3.5% from NT$23.7 billion in 2009 to NT$24.5 billion (US$0.8 billion) in 2010. The increase was mainly due to a 1.6% increase in the number of our total HiNet broadband subscribers from approximately 3.5 million as of December 31, 2009 to approximately 3.6 million as of December 31, 2010. Our HiNet subscribers remained at approximately 4.1 million subscribers as of December 31, 2009 and 2010 because the increase of our HiNet broadband subscribers was offset by the decrease of HiNet dial-up subscribers. As of December 31, 2010, approximately 82.0% of our broadband customers were also HiNet subscribers, using HiNet as their ISP.

International fixed communications

Our international fixed communications revenues increased by 1.9% from NT$15.2 billion in 2009 to NT$15.5 billion (US$0.5 billion) in 2010. This increase was mainly due to the increase in revenues from our international leased line services and international data services.

International long distance telephone services. Our international long distance telephone revenues remained constant at NT$12.9 billion (US$0.4 billion) in 2009 and 2010 because the decrease of the unit price was offset by the growth in both the traffic volume of calls using calling cards and the wholesale of the traffic from 2009 to 2010. Our international settlement revenues decreased from NT$3.5 billion in 2009 to NT$3.2 billion (US$0.1 billion) in 2010. This decrease was primarily due to the appreciation of NT dollars.

 

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International leased line and international data services. Our international leased line and international data revenues increased by 19.1% from NT$1.68 billion in 2009 to NT$2.00 billion in 2010 (US$ 68.70 million). The increase was mainly because of the overseas market expansion and the increased demand of multinational corporations.

Operating Costs and Expenses

Our operating costs and expenses increased by 2.2% from NT$142.0 billion in 2009 to NT$145.0 billion (US$4.9 billion) in 2010. This increase was primarily due to the increases in costs of handsets sold. As a percentage of revenues, operating costs and expenses increased from 71.5% in 2009 to 71.7% in 2010.

Operating Costs

Operating costs include depreciation and amortization expense, personnel expenses, cost of goods sold, interconnection and service expense, costs of materials and maintenance and spectrum usage and license fees.

Our operating costs increased by 2.3% from NT$112.7 billion in 2009 to NT$115.3 billion (US$3.9 billion) in 2010. This increase was principally a result of an increase of NT$3.0 billion (US$104.3 million) in cost of goods sold, an increase of NT$1.2 billion (US$39.8 million) in personnel expenses mainly due to increase in bonus expense because of net income growth, and a NT$0.6 billion (US$21.4 million) increase in ICT costs due to the increase in revenue, partially offset by a decrease of NT$2.2 billion (US$75.4 million) in depreciation.

Marketing

Our marketing expenses, which include personnel expenses, expenses relating to advertising and marketing-related activities and provision for bad debt increased by 0.8% from NT$22.3 billion in 2009 to NT$22.5 billion (US$0.8 billion) in 2010. This increase was principally a result of a NT$0.5 billion (US$18.4 million) increase in bonus, partially offset by a decrease of NT$0.3 billion (US$10.8 million) in expenses relating to advertising and other marketing-related activities.

General and administrative

Our general and administrative expenses increased by 6.6% from NT$3.8 billion in 2009 to NT$4.0 billion (US$0.1 billion) in 2010. This increase was principally a result of a NT$0.1 billion (US$4.6 million) increase due to the consolidation of our subsidiaries previously accounted for under the equity method, and a NT$0.1 billion (US$2.4 million) increase in bonus.

Research and development

Our research and development expenses remained flat at NT$3.2 billion (US$0.1 billion) in 2009 and 2010.

Operating Costs and Expenses by Business Segment

 

    

Domestic

Fixed
Communications

     Mobile
Communications
     Internet      International
Fixed
Communications
     Others      Adjustment     Total  

For the year ended December 31, 2010

                   

Operating costs and expenses

     67.0         62.1         15.8         14.5         6.1         (20.5     145.0   

Depreciation and amortization

     21.9         8.2         2.2         1.4         0.3         —          34.0   

For the year ended December 31, 2009

                   

Operating costs and expenses

     67.6         58.3         15.1         14.2         4.6         (17.8     142.0   

Depreciation and amortization

     24.0