Good evening and thank you for standing by for China Digital TV’s first quarter 2011 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. I would now like to turn the meeting over to your host for today’s conference, Mr. Josh Gartner.
Josh Gartner – Brunswick Group
Hello everyone and welcome to China Digital TV’s first quarter 2011 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 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.
Thank you, Josh. Hello everyone.
We are pleased to report that in the first quarter we saw steady strong demand from cable operators as they continue to invest in digitalization. We delivered strong performance, taking into account the normal seasonal slowness related to the Chinese New Year and the annual CCBN conference. Smart card shipments reached 3.63 million, representing a 41% increase year-over-year. Net revenues were $19.3 million US dollars, representing a 38% increase from the same period last year. In addition, we are particularly delighted that we were able to continue expanding our market leadership position during the first quarter. As a result of our focus on customer base expansion and day-to-day execution, our market share increased to 61.8% from 59.1% in the fourth quarter of 2010. This strengthened leadership position will help insulate us from short-term fluctuations in the demand for smart cards caused by ongoing cable network consolidation, while also preparing us to capitalize on next generation products as the pay-TV market develops in China.
According to the latest data from Analsys International, a Beijing-based market research agency, the number of China’s digital cable TV subscribers has reached 96.5 million as of the end of March. Meanwhile, the number of newly added digital cable subscribers in the first quarter of 2010 was about 4.32 million. These increases were the result of accelerated mass migration to digitalization and the cable network consolidation at provincial level.
Looking at the remainder of 2011, we believe that the policy environment will remain positive as cable operators continue pushing forward with digitalization. As you know, the government mandated a deadline for provincial-level cable network consolidation by the end of 2010. This created significant smart card demand in the fourth quarter of 2010. However, not every province was able to meet, or completely meet this deadline. As cable operators complete the consolidation process and enhance their network capabilities, we expect to see continued strong demand for smart cards during the remainder of this year, albeit at a milder growth rate than in 2010.
Looking further ahead, the continuing implementation of the three networks convergence will lead to the increasing development of innovative technologies, products and value-added services. Therefore, we remain strongly committed to R&D. We are focusing on advanced content protection technologies applied across multiple platforms, as well as interactive super-terminals that support two-way programming. As China’s digital TV market continues to mature, we are confident that our strategy to diversify our business will better enable China Digital TV to benefit from the growing market opportunities in the near future and will strengthen our position as the industry leader.
We also believe that the future is bright in our international markets. We have pressed forward with our strategy to lay the groundwork to raise our profile and revenue streams abroad.
I would now like to turn to operational developments.
During the first quarter, average selling price for smart cards remained relatively stable, with a modest decrease of 1.3% compared to the fourth quarter of 2010. As we said in the Q4-2010 earnings call, we believe that the decrease in ASP during 2011 will be contained to within 5% of last year’s price levels.
Our overseas business also showed positive signs during the first three months of 2011. We signed a contract with a company in Thailand called International Engineering Public Company Limited in the first quarter to provide our CA system product on a Chinese Mobile Multimedia Broadcasting-standard mobile TV platform. We are currently performing front-end installations under the contract and expect to ship one million smart cards over the next three years. This is the first time that the CMMB standard has been adopted overseas. In addition to Southeast Asia, we will continue to develop opportunities in other parts on the world, including South America and Africa.
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. I’m taking over the responsibility of investor relations from Eric Yuan. For those of you who haven’t met me before – I have been with China Digital TV for a year and previously looked after the Company’s internal audit process. I look forward to working with you all in the future. Please do not hesitate to contact me for any IR related questions.
As Mr. Li said, we’ve had a solid start to 2011, and we expect to see strong results throughout the year.
Now, let’s look at our financial highlights for the first quarter of 2011. Before I proceed, please note that, unless stated otherwise, all amounts are in US dollars.
In Q1-2011, China Digital TV shipped approximately 3.63 million smart cards, compared to 2.57 million and 6.10 million smart cards in Q1-2010 and Q4 2010, respectively.
Net revenues in Q1 2011 were 19.3 million, up 37.7% from last year, down 41.2% from last quarter. The annual increase was primarily due to increased smart card sales, and revenues from head-end system integration. The sequence decrease was largely due to usual seasonality associated with the Chinese New Year.
Revenues from our top five customers accounted for 23.5% of total revenues, compared to 23.6% in Q4 2010.
Gross profit in Q1 2011 was 15.4 million, an increase of 41.3% from last year, and a 42.1% decrease from last quarter. Gross margin was 79.5% in Q1 2011, compared to 77.5% in the same quarter of last year and 80.8% last quarter. The annual increase was mainly due to an increase in profitability of the system integration business, and a decrease in the cost of computer chips used in smart cards. The sequence decrease was due to a decrease in ASP and an increase in unit cost of smart cards, which was offset partially by the improving margin of the system integration business.
ASP of smart cards in Q1 2011 decreased by 1.3% compared to the quarter before. The unit cost of smart cards this quarter increased by 12.1% compared to Q4 2010.
Operating expenses in Q1 2011 were 7.1 million, an increase of 26.8% from the same period in 2010 and a decrease of 3.2% from Q4 2010.
Income from operations was 8.2 million in Q1 2011, a 56.8% annual increase and a 57.1% sequential decrease. Operating margin was 42.6%, compared to 37.4% in Q1 2010 and 58.4% in Q4 2010.
Non-GAAP net income, defined as net income excluding certain non-cash expenses, such as share-based compensation expenses and amortization of acquired intangible assets from business acquisitions and equity method investments, was 8.5 million in Q1 2011, an annual increase of 31.4% and a sequential decrease of 56.6%.
Income tax expenses in Q1 2011 were 1.6 million, compared to 0.9 million in Q1 2010 and 6.7 million Q4 2010. The annual increase is primarily due to an increase in taxable income. The sequential decrease primarily resulted from a 5.4 million withholding tax imposed by the Chinese tax authority arising from our PRC subsidiary repatriating cash offshore for the special cash dividend in Q4 2010.
Net income in Q1 was 7.9 million, an increase of 38.5% from Q1 2010 and a decrease of 9.4% from last quarter.
Turning to our balance sheet...
As of March 31, 2011, China Digital TV had cash and cash equivalents, restricted cash and deposits with maturity over three months and short-term investments totaling 214.8 million. In Q1 2011, cash flows from operations were approximately 5.7 million.
Now, let me provide our business outlook.
Based on information available on May 16, 2011, China Digital TV expects smart card shipments for the second quarter of 2011 to be in the range of 3.7 million to 4.0 million. Net revenues for the second quarter of 2011 are expected to be in the range of 20.08 million to 21.6 million US Dollars, representing a year-over-year increase in the range of 4% to 11.9%.
Thank you for listening; we will now take your questions.
(Operator Instructions) And our first question comes from the line of Mike Olson with Piper Jaffray. Go ahead.
Mike Olson – Piper Jaffray
All right. Thanks. Good morning. Just a couple quick questions. First, did you say smart card ASP’s were down 1.3% sequentially in the quarter and how do you expect smart card pricing will trend through the remainder of the year?
Hi, Mike. This is [Cynthia]. I will be the translator for today’s Q&A session. So let me start with here and refer the first question to the company.
Mike Olson – Piper Jaffray
Here is the response from Mr. Laing, the company’s CFO. The 1.3% decline of the ASP quarter-over-quarter is as expected within – for the entire year of 2011, the company expects ASP to be within 5% decline of the previous year’s level. Specifically, for the second quarter the company expects ASP to be stable, in other words, in line with first quarter’s level.
Mike Olson – Piper Jaffray
Okay. And then, just one other quick question. What do you expect gross margin to be through the remainder of 2011. Is there any reason you expect the 79% gross margin in Q1 to change significantly in the next few quarters?
Okay. Hold down one second.
Okay. Here is the response from Mr. Nan. The gross margin is the function of ASP; therefore, for the full year gross margin is expected to be slightly below the 2010 level around 75%, specifically for the second quarter gross is expected to be about the same as the first quarter, in other words, 79%.
(Operator Instructions) Our next question comes from the line of Philip Wan with Morgan Stanley. Go ahead.
Philip Wan – Morgan Stanley
Hi. Good morning. Thanks for taking my question. My first question is, could you share with us any update passing away from the CCBN Conference? And also you mentioned in prepared remarks that smart card shipment acceleration in the previous quarter was mainly due to cable operators, meeting their year-end target mandated by government? And is there any target for this year and should we expect a similar trend throughout the year? Thank you.
Hi, Philip. Your first question about update on CCBN, we didn’t hear your second question clearly?
Philip Wan – Morgan Stanley
Yeah. My second question is, in the fourth quarter, of previous quarter, we saw an acceleration for smart card shipment and in your prepared remarks you explained that it is due to some cable operators, meeting the year-end target mandated by the government. So is there any target for this year for them to meet and should we expect a similar trend? Thank you.
Okay. Thank you.
The – [one theme] that came out this year’s CCBN is a two-way interactive value-added services.
In response for this year’s trend in terms of cable network consolidation is that, even though there was a deadline by the end of 2010, not every province was able to meet this deadline. So going forward for the rest of the year 2011, we expect to see country levels, municipal levels continue to consolidate into the provincial level. As the company said in the earnings document, the amount or the level of smart card shipments in 2011 is expected to be relatively stable to last year’s level.
(Operator Instructions) We are now approaching the end of the conference call. I would like to turn over to China Digital TV’s Head of Investor Relations, Nan Hao for closing remarks. Please proceed.
Thank you for participating in today’s call. If you have any further questions, please do not hesitate to contact me. Thank you.
Ladies and gentlemen, thank you for your participation in today’s conference. That does conclude the presentation. You may disconnect. Have a wonderful day.
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