Good evening and thank you for standing by for China Digital TV’s third quarter 2012 earnings conference call. At this time, all participants are in listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections you may disconnect at this time.
Hello everyone and welcome to China Digital TV’s third quarter 2012 earnings conference call. The company’s earnings results were released earlier today, and are available on the company’s IR website at ir.chinadtv.cn, as well as on newswire services.
Today, you will hear from Mr. Dong Li, China Digital TV’s president, who will give an overview of the quarter, followed by the Company’s head of investor relations, Mr. Nan Hao, who will discuss financial results. After their prepared remarks, they will be joined by China Digital TV’s chief financial officer, Mr. Zhenwen Liang, to answer your questions.
Before we continue, please note that the discussion today will contain certain forward-looking statements made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company’s results may be materially different from the views expressed today.
Further information regarding these and other risks and uncertainties is included in the company’s registration statement on Form 20-F and other documents filed with the U.S. Securities and Exchange Commission. China Digital TV does not assume any obligation to update any forward-looking statements except as required under applicable law.
As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on China Digital TV’s investor relations website. I will now turn the call over to China Digital TV’s president, Mr. Dong Li.
Thank you, Operator. Hello everyone and welcome.
Let’s start with an update on recent trends in China’s cable market.
In regions like Zhejiang, where network consolidation has been completed, in Q3 smart card shipments returned to normal levels from their lower Q2 numbers. However, we continue to see shipment delays from provinces including Henan. We believe that delays in these regions will continue through the end of this year into the beginning of next year.
Despite these delays, we remain confident in the overall fundamentals of the market. Digitalization in China continues to move forward steadily, with the conversion rate at 65% as of the end of September 2012. There remain 70 million households in the country with cable that have not yet gone through digitalization upgrades. As a result, we expect to see stable demand over the long term.
As cable network consolidation continues to move towards completion, we have seen the initiation of a new round of bidding for smart cards by provincial cable operators. Following our success signing new contracts with Sichuan and Henan Province in Q2, we have won bids in Shanxi, Zhejiang and Ningxia this quarter. And we believe that China Digital TV is well positioned to secure additional contracts through the ongoing bidding process, both for customers that we have existing relationships with, as well as for customers in markets where we have not previously had a presence, as we did in Ningxia.
In addition, China is still at the beginning of its conversion process from standard definition to high definition set top boxes. We expect to benefit from this trend over time. For example, during the third quarter, China Digital TV won a contract in Guizhou Province for high-definition set-top boxes. Over the long term, we believe that this will be another important factor driving demand for our CA products.
Moving to China Digital TV’s third quarter 2012 operations. The industry-wide purchasing delays that I mentioned earlier impacted our Q3 smart card shipments. During the quarter, shipments were 3.84 million, compared with 4.66 million in the same period in 2011 and 3.74 million in the second quarter of 2012.
During the third quarter, average selling price, or ASP, for smart cards decreased by 1.1% compared to Q2 2012. We maintain our expectation that ASP on an annual basis will be 5 to 8 percent lower this year compared with last year.
Lower-tier city markets will be an important piece of our efforts to expand beyond traditional strongholds. While many of China’s biggest cities have largely completed the digitalization process, the country’s smaller cities remain important markets for us. We have performed well in these areas, which has helped us to maintain our leading position with a 59% share of the CA market in China, according to Zhongguang Luoda.
Our value-added services strategy also remained on a steady course of progress this quarter. We are fully committed to investment in R&D as part of our diversification strategy to expand our revenue sources.
I would like to provide an update on our cloud computing system offering. In Nanjing city, we have officially begun operations following the period of Beta testing that we have previously discussed. I’m pleased to tell you that we currently have about 15,000 subscribers and are adding about 3,000 a month.
In Q3, the Home Entertainment Box based on Android 4.0 started small scale production and shipments, and we expect to see significant increases in shipments for 2013.
China Digital TV is focused on a multifaceted growth strategy that targets international markets, value added services and new product offerings to complement our core CA business. We believe that this diversified approach will help us achieve long-term success.
I will now hand the call over to Nan Hao, our head of investor relations, to discuss our financial management.
Thank you, Mr. Li. Hello everyone.
Before we begin the discussion of our Q3 operating performance, I would like to address two non-recurring items that impacted our net income.
First, as we previously announced, China Digital TV incurred an impairment charge related to our investment in 3DiJoy Corporation. Since we invested in 3DiJoy in 2010 it consistently failed to achieve profitability and has been experiencing financial difficulties since early 2012. As a result, we decided to incur an impairment charge in the third quarter for the full value of our investment.
Second, as a result of the special dividend that we announced on November 12, 2012, China Digital TV accrued a deferred tax liability related to the undistributed retained earnings of its subsidiaries located in the PRC. Both of these items are non-recurring and do not relate to our operations.
I will now turn to the financial highlights for the third quarter of 2012. Please note that, unless stated otherwise, all amounts are in US dollars.
In Q3 2012, China Digital TV shipped approximately 3.84 million smart cards, compared to 4.66 million for the same period in 2011 and 3.74 million in Q2 2012.
Net revenues in Q3 2012 were 20.4 million, a decrease of 21.4% from the same period in 2011 and a 13.3% decrease from Q2 2012. The year-over-year decrease was primarily due to a decrease in the shipment volume of smart cards. The quarter-over-quarter decrease in net revenues was primarily due to the decrease in the sales from other products, such as multimedia home entertainment boxes and surface mounted device chipsets.
Now let me go through the major revenue components for the quarter.
Revenues from smart card sales were 18.5 million, accounting for 89.2% of total revenue, a 1.4% increase quarter-over-quarter.
Revenues from other products were 1.2 million, accounting for 5.6% of total revenue, a 71.7% decrease quarter-over-quarter. Revenue decline was largely due to a decrease in the sales from other products, such as multimedia home entertainment boxes and surface mounted device chipsets.
Revenues from our top five customers accounted for 22.9% of total revenues, compared to 27.8% in Q2 2012.
Gross profit in Q3 2012 was 15.4 million, a decrease of 26.0% from last year and a decrease of 14.0% from Q2 2012. Gross margin was 75.8% in Q3 2012, compared to 80.5% in Q3 2011 and 76.4% last quarter. The year-over-year decrease in gross margin was primarily due to a decrease in revenue from smart cards sales. The quarter-over-quarter decrease in gross margin was mainly attributable to a decrease in revenue from surface mounted device chipsets, which have a higher gross margin than other products.
ASP of smart cards in Q3 2012 decreased by 1.1% sequentially, while unit costs increased by 0.3% compared to Q2 2012.
Operating expenses in Q3 2012 were US$10.4 million, an increase of 8.7% from the same period in 2011 and a decrease of 1.0% from Q2 2012. The year-over-year increase was mainly due to the increased headcount of our R&D staff. The quarter-over-quarter decrease was primarily due to a decrease in allowance for doubtful accounts.
Income from operations in Q3 2012 was 5.0 million, a 55.7% decrease from last year and a 32.5% decrease from last quarter. Operating margin in Q3 was 24.5%, compared to 43.4% during the same period in 2011 and 31.5% in Q2 2012.
Income tax expenses in Q3 2012 were US$13.6 million, compared to US$2.5 million in the same period in 2011 and US$1.8 million in Q2 2012. The year-over-year and quarter-over-quarter increases were primarily due to an increase in deferred income tax. This was mainly attributable to the accrual of a US$12.1 million withholding tax related to China Digital TV’s decision to distribute part of the undistributed retained earnings of the Company’s PRC subsidiaries.
Net loss attributable to China Digital TV Holding Co., Ltd. in the third quarter of 2012 was US$11.4 million, compared to a US$10.3 million net income attributable to China Digital TV in the same period in 2011 and a US$7.1 million net income attributable to China Digital TV in the second quarter of 2012. This was largely due to an impairment charge and a deferred tax liability related to our special dividend that we announced in November. Neither of these non-recurring items will affect our ongoing operations.
Non-GAAP net loss attributable to China Digital TV Holding Co., Ltd. defined as net loss excluding certain one time or non-cash expenses, such as impairment loss on long-term investments, share-based compensation expenses, amortization of acquired intangible assets from business acquisitions and equity method investments, in Q3 2012 was 6.2 million, compared to a US$12.2 million non-GAAP net income attributable to China Digital TV in the same period in 2011 and a US$8.0 million non-GAAP net income attributable to China Digital TV in Q2 2012.
Turning to our balance sheet, as of September 30, 2012, China Digital TV had cash and cash equivalents and restricted cash totaling 191.6 million. In Q3 2012, cash flow generated from operations was approximately 10.4 million.
Now, let me provide you our business outlook. Based on information available as of November 20, 2012, China Digital TV expects smart card shipments for Q4 2012 to be in the range of 3.6 million and 3.9 million. Net revenues for Q4 2012 are expected to be in the range of 19.3 million and 20.9 million.
Thank you for listening; we will now take your questions.
The question-and-answer session of this conference call will start in a moment, in order to be fair to all callers who wish to ask questions, we will take one question at a time from each caller. If you have more than one question, please request to join the question queue again after your first question has been addressed.
We are now approaching the end of the conference call. I will now turn the call over to China Digital TV’s Hao Nan for closing remarks.
Once again, thank you for joining us today. Please don’t hesitate to contact us if you have any further questions. Thank you for your continued support and we look forward to talking with you in the coming months.
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
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