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China Techfaith Wireless Comm. Tech. Ltd (NASDAQ:CNTF)

Q1 2006 Earnings Conference Call

May 15, 2006, 7:00 p.m. EST

Executives

Defu Dong, Chief Executive Officer

Gilbert Lee, President and Chief Operating Officer

Peter Wei, Chief Financial Officer

David Pasquale, The Ruth Group

Analysts

Brian White - Jefferies

Tienyu Sieh - Merrill Lynch

Adele Mayu -

Ranjit Thomas - Tracer

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2006 China TechFaith Wireless Communication Technology Limited Earnings Conference Call. (Operator Instructions) I would now like to turn the presentation over to Mr. David Pasquale of The Ruth Group. Please proceed.

David Pasquale

Thank you, operator, and thank you everyone for joining TechFaith’s first quarter 2006 earnings call. With us today are the company’s Chief Executive Officer, Mr. Defu Dong; President and COO, Mr. Gilbert Lee; and acting CFO, Peter Wei.

After management’s prepared comments, we will have time for any questions. If you have not yet received a copy of today’s results release, please call The Ruth Group at 646-536-7003, or you can get a copy of the release off of TechFaith’s website.

The Company’s attorneys advise that this call will contain forward-looking statements. These statements are made under the safe harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as “will”, “expect”, “anticipate”, “future”, “intends”, “plans”, “believes”, “estimates”, and similar statements.

Among other things, the business outlook and quotations from management in the call, as well as TechFaith’s strategic and operational plans, contain forward-looking statements. TechFaith may also make written or oral forward-looking statements in its periodic reports to the U.S. Securities and Exchange Commission on Forms 20-F and 6-K and in the annual report to shareholders, in press releases and other written materials, and in oral statements made by its officers, directors, or employees to third parties. Statements that are not historical fact, including statements about TechFaith’s beliefs and expectations, are forward-looking statements.

Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. Potential risks and uncertainties include, but are not limited to: TechFaith’s limited operating history; mobile handset brand owner’s discontinuation or reduction of the use of independent design houses; TechFaith’s ability to retain existing or attract additional international customers; TechFaith’s earnings or margin declines; failure of competing against new and existing competitors; and other risks outlined in TechFaith’s filings with the U.S. Securities and Exchange Commission, including its registration statement on Form F1, as amended.

TechFaith does not undertake any obligation to update any forward-looking statements except as required under applicable law. I would now like to turn the call over to Mr. Defu Dong. Please go ahead, sir.

Defu Dong

Thank you, David, and welcome to our first quarter call. The quarter developed as we expected and was a transition period. Results were in line with prior guidance and we remain optimistic about our run in 2006.

The upside in first quarter revenue compared to prior guidance was primarily due to the relatively faster growth of existing customers. We remain confident, based on the success and outlook of our three business units: handset design, smart phone and pocket PC, and application software.

Our focused structure differentiates TechFaith and is helping us work effectively with customers globally to speed the design process, reduce the time to market and lower the costs. Our customers remain very positive and we have the results in place to support them.

With the first quarter behind us, we believe TechFaith is back on the fast growth trajectory we were previously on. We are very positive about our growth prospects for 2006, given the strength of our core business and the expected global growth of the handset sales.

New technologies are being embraced at a faster pace by consumers, which are driving carriers and handset brand owners to accelerate their adoption of advanced technologies to remain competitive.

Software remains the backbone of these new feature sets and TechFaith has the realigned structure, handset application software and design strengths, and the long-term customer relationships already in place to benefit.

In line with our growth effort, we recently expanded our longstanding relationship with QualComm to form a new mobile software company. The new company, TechFaith Software China Limited, will develop software for wireless devices. The independent entity will be based in Beijing and Hangzhou. TechSoft will receive cash and in-kind contributions up to $35 million from both parties, subject to performance milestones and other conditions.

It is important, [the initial [inaudible] followed on the significant accomplishments], and the dedicated results we have. The company will focus on application software for handset uses. In the initial phase, our product will be based on QualComm’s platform.

In terms of our overall outlook for the year, based on current forecasts, we are reiterating our prior guidance. We expect sequential revenue and profit growth will resume in the second quarter based on existing customer orders and our successful business diversification efforts. We already have multiple new customers ramping design programs with us, including one in Japan and at least two in Europe. We expect a big ramp in 2006, and all efforts are dedicated to reaching our goal.

TechFaith continues to expect revenue from smart phone opportunities will contribute 25% of our 2006 revenue. Nine new contracts have already been signed, reflecting the large, global opportunity we are pursuing in this area. Five of the contracts are in China, two in Europe, one in Southeast Asia, and one in Russia.

Smart phone adoption is accelerating, given the compelling benefits and the convergence of telecommunications, e-mail, music, camera and many, many other features. The complexity of the devices and the required software also continues to increase with each feature set added. This trend bodes well for TechFaith, given our expertise in helping customers address this complexity in a cost-down environment.

As part of our smart phone efforts, we are aggressively going after the Windows Mobile and Windows Media opportunity. We have been an important partner to Microsoft in this area, and recently signed an M.O.U. to establish a strategic partner relationship with Windows Mobile and Windows Media technology.

Both TechFaith and Microsoft will work together to improve the user experience and market share of Windows Mobile-based devices, while reducing the time to market and lowering development costs. TechFaith’s strategic partner relationship will give us a further competitive advantage in the marketplace as we successfully execute our business strategy.

Our other goal is to increase the percentage of revenue from product design for international markets from 5% of revenue in 2005 to approximately 20% to 30% in 2006, with demand from Japan, United States, Russia, India and other European countries.

Now, let me turn the call over to Dr. Gilbert Lee for a detailed review of the financials. Gilbert, please go ahead.

Gilbert Lee

Thank you, Mr. Dong, and Mr. Pasquale. Good morning, everyone. First of all, let me review several numbers.

Net revenue for Q1 of 2006 was $12.8 million, as compared to $21.5 million for Q1 of 2005. Revenue in the quarter came in as expected, due to lower orders from a major customer, along with TechFaith’s discontinuance of two out of the four GSM platforms to focus on 3G opportunities.

Further, as Mr. Dong just noted, we remain confident in our earlier guidance and expect our business to ramp through 2006.

Design fee revenue for Q1 of 2006 was $9.0 million, as compared to $16.5 million for the same period in 2005. Royalty income in Q1 of 2006 was $1.8 million, as compared to $3.1 million for the same period in 2005.

Revenue from component products was $2.0 million in Q1 of 2006, as compared to $1.8 million in the same period in 2005. In Q1 of 2006, about 65.4% of revenue from component products was from the sales of wireless modules, and 34.6% from sales of other component products.

Net income for Q1 of 2006 was $1.3 million, or $0.03 per weighted average outstanding ADS, basic and diluted, compared to net income of $8.3 million or $0.25 per basic weighted average outstanding ADS, or $0.22 per diluted weighted average outstanding ADS in the same period in 2005.

While we continue to leverage our relative low operating costs while supporting a higher revenue base, our gross profit margins was 44% in Q1 of 2006, compared to 58% in Q4 of 2005. The decline was primarily due to our lower revenue base compounded by higher investment costs associated with our expanded smart phone and 3G efforts.

Capital expenditures totaled $1.3 million for Q1 of 2006, representing a 3.9% increase from the same period in 2005, and a 31.2% decrease from Q4 of 2005, as a result of our expanded expenditure on operational activities.

As Mr. Dong talked about earlier, we are very positive and optimistic about our prospects for the full year 2006. Specifically, based on existing orders, we expect second quarter of 2006 revenue to be about $24 million, with a net income of $8.5 million.

Finally, we continue to expect that international brand owners will still represent 60% to 70% of our revenue in 2006. The handsets that go to international markets is expected to increase from 4.6% to the range of 20% to 30%.

Operator, that concludes my prepared comments. We can now take any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Brian White - Jefferies.

Brian White - Jefferies

Good morning, Mr. Dong, Gilbert. Could you talk a little bit about the nine new smart phone contracts? First of all, are these all with different customers? How many of these customers are new customers for China TechFaith?

Defu Dong

Gilbert, I will answer this question. For the smart phone business, we have five contracts in China. Four are new customers, one is an older customer who is buying new technology. For Europe, we have two customers. One is a new customer, one is an older customer. For us, it is a new customer. For [inaudible] it is a new customer.

Brian White - Jefferies

Okay. And when we look at what type of customers these are, can you just give us a feel for what percent, or number of customers that are OEMs? What number are distributors? What number are operators? Just to give us a feel for the customer base.

Defu Dong

For China market, [five] are OEMs. Some are new licensing companies from the China government. For the [inaudible] China, and [inaudible] is also China. In Europe, one is OEM, one is China.

Brian White - Jefferies

One is China, okay.

Defu Dong

The type of customer for Europe is operator.

Brian White - Jefferies

Is an operator. Okay. What do you think the revenue contribution would be? Is this what is going to make up the 25%, these nine contracts? Are there other contracts you have to win to hit that number, the 25% of '06 sales from smart phones?

Defu Dong

These nine contracts contributed 70% of the latest guidance, I think.

Brian White - Jefferies

70%?

Defu Dong

Yes.

Brian White - Jefferies

Can you talk about what customers were over 10% of revenue in the quarter?

Defu Dong

Gilbert, you will answer this question.

Gilbert Lee

In Q1, the big contributor is still NEC.

Brian White - Jefferies

Okay. So was there any other customer over 10%, or just NEC?

Gilbert Lee

No, just NEC.

Brian White - Jefferies

Do you have that percentage, Gilbert?

Gilbert Lee

30%.

Brian White - Jefferies

Okay, thank you.

Operator

Our next question comes from Tienyu Sieh - Merrill Lynch.

Tienyu Sieh - Merrill Lynch

Good morning. Can you tell us a little bit about the R&D expenses? That has picked up quite a bit. Is this all related to smart phone development, or is this for some of the other areas as well?

Gilbert Lee

As we stated before, it is the smart phone plus 3G.

Tienyu Sieh - Merrill Lynch

Right, okay.

Gilbert Lee

We will concentrate on these two areas. And also, we shifted a lot of engineers to 3G. Today, we have about 700 engineers in GSM and CDMA1X. All other engineers will shift to 3G and smart phone.

Tienyu Sieh - Merrill Lynch

And how many of your total head count, now?

Gilbert Lee

As of today it is about 2,300.

Tienyu Sieh - Merrill Lynch

Thanks.

Defu Dong

Our total at the end of the year is 3,000.

Gilbert Lee

Yes, it is 3,000.

Tienyu Sieh - Merrill Lynch

Okay, thanks.

Operator

(Operator Instructions) Our next question comes from Adele Mayu.

Adele Mayu -

Good morning Mr. Dong and Gilbert. I have several questions. Your guidance on 2Q06 and for the full year remain unchanged. Are there any new developments from the NEC front, or are you still seeing sort of 15% to 20% revenue mix for the whole year for NEC?

Defu Dong

For the full year, actually we have two [Europe] new customers and one [Japan] new customer who are contributing revenue. I think NEC for the full year may be less, 10% to 15% of our revenue.

Adele Mayu -

Just on the other income line, how much of that is from interest income? It looks like there is something sort of like what you received from the government last quarter. Is there any amount there? I am talking about $1.2 million in the other income line?

Defu Dong

Gilbert, please translate this question for me.

Gilbert Lee

It is about $1 million every quarter, it is a little bit over $1 million every quarter.

Adele Mayu -

Every quarter from the government or from the interest income?

Gilbert Lee

From the interest income. There is about over $1 million.

Adele Mayu -

About over $1 million. That is high. I didn't get your prior answer. Could you give us a breakdown again on the allocation of the headcount in your three business areas?

Gilbert Lee

It is 1,500 on the hand set design. It is about 500 on smart phone. It is 300 on application software.

Adele Mayu -

Okay. In terms of the 1,500 on 2G versus 3G?

Gilbert Lee

2G is about 700 and 3G is over 1,000.

Adele Mayu -

Okay.

Defu Dong

2G including CDMA 1X and the GSM.

Adele Mayu -

Okay. How much smart phone revenue do you see? Can you give me an idea in terms of how you see the growth of smart phone in 2007?

Gilbert Lee

I think smart phones, we will easily see more than 100% growth in units in 2007.

Adele Mayu -

For smart phone, TechFaith is functioning sort of as an ODM. With your plans to grow further into international markets, do you think it makes sense for you to transform your core business more into an ODM model as well?

Gilbert Lee

No. We don't have that intention at all. Actually, in the second half of this year, in '07 we will start selling the design of a smart phone, not only the complete unit. At the present time, we didn't plan any investment in the production line, in the manufacture.

Adele Mayu -

Great, that is all I have. Thank you.

Operator

Our next question comes from Ranjit Thomas - Tracer.

Ranjit Thomas - Tracer

Hi. What is the revenue contribution you expect from smart phones next quarter? Can you also tell us what kind of gross margins you expect in the smart phone business?

Defu Dong

In Q2 we expect smart phone contribution is $3 million, is a little bit above 10%; 12% or 13% from smart phones. The margin at this point is somewhere around 30%.

Ranjit Thomas - Tracer

Great, thank you very much.

Operator

(Operator Instructions) Our next question comes from Tienyu Sieh - Merrill Lynch.

Tienyu Sieh - Merrill Lynch

Just to clarify, in terms of the ASP can you give us a rough indication of what the ASP for the smart phone is? As far as the gross margin is concerned, will you hit the 30% level right away or do you think that because maybe you don't have scale right up front that the margins will build through the year? Maybe start out a little lower. Can you give us a sense of how that would progress?

Gilbert Lee

When we talk about smart phones, that is a generic name. Actually we can separate it into two categories: one is smart phone, one is called pocket PC phone. The difference is a smart phone only has a keypad. In the pocket PC phone we also have a touch screen using a stylus.

For smart phone, the current ASP is anywhere between $170 to $210. The pocket PC is anywhere between $240 to $300. Obviously on the pocket PC side, the margin is a little bit higher. Just now, I just mentioned the margin at this point of the orders we have received is a minimum of 30%.

We understand the way ASP [fluctuates], but I think by the end of this year we will still maintain well above 20% gross margin.

Defu Dong

I think the GSM for Q4 we will have the average CDMA under HSDPA, EVDO, Windows Mobile phone, the margins will be also above 70%, I think.

Gilbert Lee

Mr. Dong is correct, about the product mix. In this year, we have about 80% of 2.5G in the GSM. But next year, we just referred to the situation, 80% will be a 3G phone. Obviously 3G phones have much higher margin.

Tienyu Sieh - Merrill Lynch

Great, thank you for clarifying.

Operator

Our next question comes from Brian White - Jefferies.

Brian White - Jefferies

I am wondering, what do you think is a good target for the end of '06 in terms of gross margins and operating margins for the entire company?

Gilbert Lee

As we explained in the guidance, it is about 30% for the net margins.

Brian White - Jefferies

By the fourth quarter of '06, 30%?

Gilbert Lee

Yes.

Brian White - Jefferies

Okay. When we look at just the competitive environment, who are you competing with most often? What type of company in the smart phone market?

Defu Dong

In the smart phone market our main competitor is a Taiwan company. Smart phones and the pocket PC business, we have confidence because today the [phone makers don't understand in the global market], only [AGTA] and TechFaith have the full technology. Full technology including GPRS under Windows Mobile Phone; CDMA Wireless Windows Mobile Phone; WUMTS Windows Mobile Phone; EVDO Windows Mobile Phone; HSDPA Windows Mobile Phone; and TD-SCDMA Windows Mobile Phone. Only [AGTA] and TechFaith have this solution. So in smart phone and the pocket PC, I have confidence that the market will be good.

On the other hand, with Windows [we have a very close relationship with Microsoft. [Inaudible] so with Microsoft as a partner, we have the full vendor, Windows Mobile, I think] this combination is very good in the market.

Brian White - Jefferies

Okay, thank you.

Operator

There are no further questions in the queue. I would like to turn the call back over to management.

Gilbert Lee

Mr. Dong, do you have anything or should I start first?

Defu Dong

No, thank you.

Gilbert Lee

I think we did what we said before. Q1 is a promising quarter. In Q2, at the present stage, we think is pretty much in line with what we said before. We are very positive -- I can only use a positive word -- optimistic about our full year. I think our strategy realignment 10 months ago really worked. Now every team in our company is very busy, and we just have all kinds of orders coming in.

I am looking forward to meeting you every time with more positive news. Thank you for today.

Defu Dong

Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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