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Executives

Henry Fraser – Brunswick Group

Dong Li – President and Chief Marketing Officer

Eric Yuan – IR Officer

Zhenwen Liang – CFO

Analysts

Philip Wan – Morgan Stanley

Jie Liu – Auriga

Sam Lawn – Oppenheimer

China Digital TV Holding Co., Ltd. (STV) Q3 2010 Earnings Call Transcript November 16, 2010 7:00 PM ET

Henry Fraser

Hello everyone and welcome to China Digital TV’s third quarter 2010 earnings conference call. The company’s earnings results were released earlier today, and are available on the company’s IR website at http://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. Eric Yuan, who will discuss the 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, our results may be materially different from the views expressed today.

Further information regarding these and other risks and uncertainties is included in our 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. Li.

Dong Li

Thank you, Henry. Hello everyone.

We are pleased to report that in the third quarter we achieved 21.1 million US dollars in revenues, exceeding our high-end guidance and hitting a record high. Encouraged by government policies related to three network convergence and ongoing industry consolidation, we saw Chinese cable operators continuing to accelerate investment in digitalization projects over the quarter. As a result of the active industry environment, we shipped about 3.95 million smart cards in the third quarter. At the same time, we expanded our lead over competitors, capturing about 55% market share in CA card shipments during the quarter, according to data compiled by an independent market research firm.

I would like to take you through some policy updates before turning to the operational results.

During the last quarter, the 12 pilot cities and regions in the three-network convergence project submitted their convergence plans to the central government. The plans covered both practical implementation and industry supervision issues. At the same time the national tax bureau published a tax incentive notice, granting digital cable operators in 11 provinces including Shanghai, Chongqing and Jiangsu, exemptions from business tax for three years beginning 2010 for their basic digital TV subscription revenues. We believe this policy will further encourage cable operators to promote digitalization.

We believe China Digital TV is well positioned for long-term development in China’s pay-TV industry with its broad operator customer base, deep understanding of the industry and advanced content protection technologies. In our view, for the fourth quarter of this year and the first half of 2011, operator demand for CA products will remain relatively strong.

I would now like to talk about operational developments in more detail.

We are pleased to see continued strength in our smart card business and milder ASP erosion. As we previously indicated we believe the degree of decline in ASP in year 2010 will be within 10% compared with 2009. A significant portion of new orders for smart cards is coming from third and fourth tier cities in China, which have been buying large volumes of smart cards over the past two quarters, bringing total smart card shipment growth in the first nine months of 2010 to 57% year-over-year.

We have been making exciting progress on a number of fronts over the last quarter…

First, our integrated chip product for set-top boxes, which we commercialized in the second quarter, began generating revenue in the third quarter. Given the encouraging customer feedback we've received, we believe this product should make a meaningful contribution to revenue over the next few quarters.

We also made some progress with our overseas business, signing a contract with an operator in Myanmar in the third quarter. In 2011, we will continue to seek opportunities in emerging markets including Latin America, South East Asia, Central Asia and Eastern Europe.

Furthermore, at a recent exhibition, we launched our self-developed Pro DRM product that supports interactive TV applications on IPTV and two-way digital cable platforms. The new product is now undergoing testing by a national operator and will be ready for use in commercial projects in the coming quarters. This progress demonstrates China Digital TV’s ongoing efforts to leverage our unique position in the industry to expand our product line and meet operators’ needs in the post-digitalization era.

I will now hand the call over to Eric Yuan, our head of investor relations to discuss our financial management.

Eric Yuan

Thank you, Mr. Li. Hello everyone.

To reiterate Mr. Li’s points, we’ve had three strong quarters in a row, and we are reasonably confident about our business outlook in the near future. In the third quarter we added 20 new hires in China, focusing on the new business initiatives and bringing the total headcount to 540. We expect that our operating expenses will increase modestly in the coming quarters as we continue to hire talents for our new businesses. At the same time, we will make efforts on multiple fronts to enhance overall efficiency to support profitable growth.

Now, let me take you through our financial highlights for the third quarter of 2010. Before I proceed, please note that, unless stated otherwise, all amounts are in US dollars.

In the third quarter of 2010, China Digital TV shipped approximately 3.95 million smart cards. Net revenues in Q3 increased to 21.1 million, up 74.5% from last year, and 10.4% from last quarter, due to increases in both smart card sales and service revenues.

Revenues from our top five customers accounted for 27.1% of total revenues, compared to 28.9% in Q2 this year. In Q3, the average selling price of smart cards decreased by 2.23% compared to the second quarter of 2010. The unit cost of smart cards increased by 2.49% compared to the second quarter of 2010.

Gross profit in Q310 was 16.5 million, an increase of 84.3% annually and 9.3% sequentially. Gross margin was 78% in Q3, compared to 73.8% in the same quarter of last year and 78.7% last quarter. The annual increase in gross margin mainly reflects the decline of non-chip costs during the past year while the slight sequential decrease was primarily due to the increase in revenues from our service business, which has slightly lower margins than smart card shipment.

Operating expenses in the third quarter were US$6.2 million, an increase of 23.5% from the same period in 2009 and relatively flat compared to the second quarter of 2010.

Operating income was 10.3 million in Q310, while operating margin was 48.8%, compared to 32.5% in Q309 and 46.5% in Q2 this year.

Net income in Q310 was 10 million, translating to earnings per share of 17 cents.

Turning to our balance sheet...

As of September 30, 2010, China Digital TV had cash and cash equivalents, restricted cash and short-term investments totaling 252.5 million. In the third quarter of 2010, cash flow generated from operations was approximately 12.8 million.

Now, let me provide our business outlook.

Based on information available as of November 16, 2010, China Digital TV expects smart card shipments for the fourth quarter of 2010 to be in the range of 3.7 million to 3.9 million. Net revenues for the fourth quarter of 2010 are expected to be in the range of 20.80 million to 21.79 million, representing a year-over-year increase of between 52% and 59%.

Thanks for listening; we will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Philip Wan with Morgan Stanley. Please proceed.

Philip Wan – Morgan Stanley

Hi good morning Mr. Li, Mr. Liang and Eric. Thank you for taking my questions and first of all congratulation on a very strong quarter. And my first question start out with the smart card shipments obviously we see acceleration in smart card shipment in China and I’m just curious about the total shipments you currently have. How much of them are actually coming from this market replacement. As I understand that your company started to ship smart cards back in 2005 and have you seen smart card replacement cycle began and can you please remind me that what is the average life cycle for your smart card? Thank you.

Eric Yuan

Great. Thank you, Philip. Mr. Li will help answer this question.

Dong Li

[Foreign Language].

Eric Yuan

Okay. So, Philip, the portion of the replacement card you mentioned in the total smart card we sold last quarter is generally minimum, because actually we don’t see the replacement cycle kicking in at this moment, because actually the security features of the smart card that we sold has not been under attack and so the physical life of the smart card also has not expired.

Philip Wan – Morgan Stanley

Okay, thank you Eric. And then my second question is about your new business, unless you give us some update on the status of your OpenV investment and also could you also comment on the progress of your other investments which is 3DiJoy?

Eric Yuan

Okay, sure. I would like to – I will turn to Mr. Liang to answer this question.

[Foreign Language]

Zhenwen Liang

[Foreign Language].

Unidentified Company Speaker

So, I tell you as we’ve mentioned in earnings release before there is no sufficient information available for us to evaluate any possible investments on the OpenV investment. So, actually as of today we don’t have any new information to tell investors.

[Foreign Language]

Eric Yuan

So, regarding to 3DiJoy we think they are still developing their solutions for the handheld devices, so we think maybe in the next year they will see some revenues though that amount will not be big.

Philip Wan – Morgan Stanley

Thank you, Eric. And then my last question is about your – obviously you have a very strong cash position now and also in the cash flow generated this quarter, could you please give us some color on what’s your plan to do with the cash and would you consider paying dividend?

Eric Yuan

Okay. Mr. Liang Xu will answer this question.

[Foreign Language]

Eric Yuan

Okay. So the use of our cash we look at – we still look at the investment opportunities and we mainly focused on the three areas. One is we look at new types of content protection and security technologies. The second is the new solutions can be used in the Digital TV platform. And the third one is we’re still focused on the content aggregation business such as to aggregate movie and the TV dramas and TV games et cetera into these areas.

Philip Wan – Morgan Stanley

Okay, all right. [Foreign Language].

Eric Yuan

Regarding the dividend issue I think this issue is actually being raised on the level of Board of Directors from time-to-time but at this point of time we don’t have make any decisions on this issue.

Philip Wan – Morgan Stanley

Okay. Thank you, Eric. I’ll get back in queue.

Operator

Your next question comes from the line of Jie Liu with Auriga. Please proceed sir.

Jie Liu – Auriga

Okay. Hi, good morning everyone. Congratulations on the nice results and the guidance. I got three questions basically. First of all, which line item is the revenue associated with your system in a packaged solution locked into. Is it the other products on page two of your press release?

Unidentified Company Speaker

Jie, you mean the integrated chip products or...

Jie Liu – Auriga

Right. Your IC product.

Unidentified Company Speaker

In Q3, right.

Jie Liu – Auriga

Yes, in Q3.

Unidentified Company Speaker

The amount in Q3 is quite some more, it is in the line of Other Products.

Jie Liu – Auriga

Okay, that’s great. I got it, Other Products. So, my next question is basically a follow-up of this one. How should we think about this – the revenue opportunities associated with this product line and do you think this will cannibalize your smart card sales in 2011?

Unidentified Company Speaker

Okay. Dong Li will help answer this question.

[Foreign Language]

Unidentified Company Speaker

Okay. So we are happy to say that the – our operator customers showed strong interest in this new product. And we expect the integrated chip solution, the sales can account 5% or even more in 2011.

[Foreign Language].

Unidentified Company Speaker

There will be no cannibalization effect you mentioned because the chip solution is sold combined with our smart card solution.

Jie Liu – Auriga

Okay, that’s great. My last question is how should we think about your seasonality in the first quarter of next year, I recall from your press release you’ve said that you’re relatively optimistic about the first half of next year. Does that mean that the first quarter of next year will be better than seasonal?

Eric Yuan

Okay, our President Li will answer this question. [Foreign Language].

Dong Li

[Foreign Language].

Eric Yuan

Okay, we expect in the first half of 2011 the smart card shipment will continue to increase on a year-over-year basis. But having said that we still think there will be some seasonality effect in the first quarter, because of the lunar year effect and there will be a large industry exhibition in the first quarter of each year, which were also impacted, the shipment pattern from our operative customers.

Jie Liu – Auriga

Okay, understood. While thank you very much and congratulations again.

Unidentified Company Speaker

Thank you, Jie.

Unidentified Company Speaker

Thank you, Jie.

Operator

(Operator Instructions). Your next question comes from the line of Sam Lawn with Oppenheimer. Please proceed.

Sam Lawn – Oppenheimer

Hi good morning everyone, congratulations on an outstanding quarter. Few quick questions on your pricing, I’ve noticed that your ASP is dropping as expected and it’s still around 10% for the year-on-year basis, I’m thinking. But your costs are rising and with inflation everything and what that mean. How do you guys see that for the next upcoming years that’s around the same rate or what sort of way to model that? Thanks.

Unidentified Company Speaker

Okay. Thanks Sam.

[Foreign language].

Eric Yuan

So Sam I think in the first three quarters of this year ASP declined by about 6%. So Mr. Yuan said there are mainly two reasons. One is the market competition is not as intent as we accepted. The second is market demand is very strong above our expectations. These two parts help us to contain the ASP decline using our guidance.

[Foreign Language]

Eric Yuan

So Sam, we think it’s still too early to speak to the ASPs duration and portfolio of 2011. While for the first half of 2011, we think the pace of ASP decline make copy the trend of this year.

[Foreign Language]

Eric Yuan

The unit costs will be kept stable generally speaking but it will fluctuate from quarter-to-quarter because as we said in the release that the main reason of this quarters increase in unit of course is due to some non-chip cost.

Sam Lawn – Oppenheimer

Okay. In terms of pricing then what have you guys seen your competitors do, obviously you guys are the biggest ones in the market, but still what did your competitors do, are they lowering their prices to try to gain market share or everyone pretty much on the same pace?

Eric Yuan

I think we charge the smart card in par with foreign competitors well, we may charge about 10% premium compared to our domestic competitors.

Sam Lawn – Oppenheimer

Okay. Thank you.

Eric Yuan

Thank you Sam.

Operator

With no further questions in the queue I’d like to turn the call back over to Eric Yuan, Head of Investor Relations for closing remarks. You may proceed sir.

Eric Yuan

Again thank you for joining us today. If you have any questions please do not hesitate to contact our investor relations team by sending a e-mail to ir@chinadtv.cn.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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