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China Digital TV Holding Co., Ltd (NYSE:STV)

Q4 2011 Earnings Call

February 29, 2012 7:00 p.m. EST

Executives

Nan Hao - Senior Supervisor, IR

Dong Li - President and CEO

Zhenwen Liang - CFO

Analysts

Philip Wan - Morgan Stanley

Operator

Good evening and thank you for standing by for China Digital TV's fourth quarter and full year 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 fourth 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 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, Josh. Hello everyone and welcome.

In the fourth quarter, we were once again pleased to see strong smart card demand, as a result of the ongoing cable network consolidation and cable operators' continued investment in digitalization projects. In particular, we experienced strong demand from several provinces, including Heilongjiang, Guangdong, Jiangsu, Zhejiang and Shandong.

Smart card shipments reached 5.38 million in the fourth quarter, compared to 6.1 million in the same period in 2010, and 4.66 million in the third quarter of 2011. Robust smart card shipments led to a 12.7% increase in net revenues from the third quarter of 2011. The year-over-year net revenue decrease is due to a spike in smart card demand in the fourth quarter of 2010. This spike was caused by the provincial cable network consolidation approaching a government mandated deadline at the end of 2010. Looking at 2011 as a whole, we achieve a 12.8% annual growth in smart card shipment volume and a 13.7% annual increase in net revenues, surpassing outstanding results in 2010.

During the fourth quarter, we held a strong market share of 58% of CA card shipments, according to Zhongguang Luoda Consulting, a Beijing based research agency. For the year, we held a 56.8% market share. We are pleased to have further solidified our market share over 2011, which is a demonstration of our effective execution.

During the fourth quarter, average selling price, or ASP, for smart cards decreased by 1% compared to the third quarter of 2011. We believe that ASP decline in 2012 will stay within 5-8% of last year's pricing level.

Let me provide a brief market update. According to Zhongguang Luoda, by the end of 2011, the total number of China's digital cable TV subscribers reached 105 million. This included 6.1 million newly added digital cable subscribers in the fourth quarter, compared to 4 million newly added digital cable subscribers in third quarter of 2011.

In 2011, digital penetration increased alongside steady progress in cable network consolidation. China Digital TV continued to benefit from cable operators' investment in diversified pay-TV services. However, commercialization of such value added services were in the early stages and the pace of market adoption remains uncertain in 2012.

Looking at 2012, given the mixed market sentiment, we expect 2012 sales of smart cards to be in line with 2011 levels.

I would now like to turn to operational developments during the fourth quarter.

In the domestic market, China Digital TV received a 10 million RMB subsidy from Zhongguancun Science Park to support video cloud computing technology development. In addition, China Digital TV also started cloud computing system deployment in Nanjing city. The project has entered a trial run stage, covering a user base of 180,000 and has deployed 1,000 concurrent knots. China Digital TV is now also actively seeking trial partnerships with cable operators and telecom operators in other cities and provinces.

In international markets, we continued to explore opportunities and expand our overseas partnerships. In the fourth quarter, we continued our cooperation with One Sky, the Thailand subsidiary of GMM Grammy Public Company Limited, with another moderate shipment of surface mounted device chipset, or SMD chipset for short.

In addition, China Digital TV, in partnership with Motorola, reached an agreement with Malaysian ABN TV Station. According to the agreement, China Digital TV will deploy CA head end system and provide licensor software. We are now preparing for the head end system deployment.

Going forward, we will still focus on developing our core CA business both in China and in selected global markets. In addition, we plan to continue investing in research and development to create next generation products and service solutions to capture market opportunities.

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

Nan Hao

Thank you, Mr. Li. Hello everyone.

As Mr. Li said, the fourth quarter of 2011 was strong for us, and we expect to see continued solid results in Q1 2012 driven by ongoing cable network consolidation.

Before getting to financial highlights, I'd like to provide you an update about the dividend payment. The dividend payment was initially scheduled to be made on or around December 30, 2011, but due to a delay in the regulatory approval process by the foreign exchange authority in China for the repatriation of U.S. dollars, we have not been able to pay out the special cash dividend to our shareholders. China Digital TV's management stands behind our dividend policy and we will notify the market of a new payment date as soon as possible. We now expect the dividend to be paid at the end of March or the beginning of April.

I will now continue with financial highlights for the fourth quarter and full year of 2011. Again, please note that, unless stated otherwise, all amounts are in US dollars.

In Q4 2011, China Digital TV shipped approximately 5.38 million smart cards, compared to 6.10 million in the same period in 2010 and 4.66 million in Q3 2011. During the full year, we shipped 18.31 million smart cards, compared to16.23 million in 2010.

Net revenues in Q4 2011 were US$29.2 million, a decrease of 11.2% from the same period in 2010 and a 12.7% increase from the third quarter of 2011. The year-over-year decrease is due to a spike in smart card demand in Q4 2010 caused by the year-end deadline in provincial cable network consolidation.

Revenues from our top five customers accounted for 25.8% of total revenues, compared to 29.7% in Q3 2011.

Gross profit in Q4 2011 was US$23.6 million, a decrease of 10.9% from last year and an increase of 13.4% from Q3 2011. Gross margin was 81.1% in Q4 2011, compared to 80.8% in Q4 2010 and 80.5% last quarter. The year-over-year and the quarter-over-quarter increases in gross margin were mainly due to a decrease in the unit cost of smart cards.

ASP of smart cards in Q4 2011 decreased by 1% compared to the quarter before, while the unit cost decreased by 5%. In 2011, the ASP of smart cards decreased by 1% compared to 2010, and the unit cost decreased by 10%.

Operating expenses in Q4 2011 were US$10.9 million, an increase of 47.9% from the same period in 2010 and an increase of 13.4% from Q3 2011.The year-over-year increase was mainly due to increases in marketing activities expenses, increased headcount of R&D and sales and marketing staff, and share based compensation expenses related to options granted to employees in 2011. The quarter-over-quarter increase was mainly caused by the increase in marketing expenditure and in performance-based annual bonus compensation.

Income from operations in Q4 2011 was US$12.8 million, a 33.5% decrease from last year and a 13.4% increase from last quarter. Operating margin in Q4 2011 was 43.7%, compared to 58.4% in the same period last year and 43.4% in Q3 2011.

Income tax expenses in Q4 2011 were US$3.1 million, a decrease of 54.4% from the same period last year and an increase of 21.3% from Q3 2011. The year-over-year decrease was mainly due to withholding tax imposed by the Chinese tax authority arising due to our PRC subsidiary repatriating cash offshore for the special cash dividend declared in November 2010. The quarter-over- quarter increase was largely due to an increase in taxable income.

Net income attributable to China Digital TV Holding Co., Ltd., in Q4 2011 was US$11.5 million, an increase of 30.7% from the same period in 2010 and an increase of 11.8% from Q3 2011.

Non-GAAP net income attributable to China Digital TV Holding Co., Ltd, defined as net income excluding certain non-cash expenses, including share-based compensation expenses, amortization of acquired intangible assets from business acquisitions and equity method investments, in Q4 2011 was US$13.6 million, a decrease of 30.5% from the same period in 2010 and an increase of 11.8% from Q3 2011.

Turning to our balance sheet...

As of December 31, 2011, China Digital TV had cash and cash equivalents and restricted cash totaling US$257.2 million. In Q4 2011, cash flow generated from operations was approximately US$29.5 million.

Now, let me provide you our business outlook.

Based on information available as of February 29, 2012, China Digital TV expects smart card shipments for the first quarter of 2012 to be between 3.5 million and 3.7 million. Net revenues for the first quarter of 2012 are expected to be between US$ 18.3 million and US$ 20.1 million.

Thank you for listening; we will now take your questions.

Question-and-Answer Session

Operator

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. One moment please for the first question.

Our first question comes from the line of Philip Wan with Morgan Stanley.

Philip Wan - Morgan Stanley

Thanks. Good morning, Mr. Li, Mr. Liang and Nan Hao. Thanks for taking my question.

First of all, could you share with us the progress of China -- cable TV digitalization in China from what you have seen? For instance, how many province have already completed the consolidation? And in what percentage of network has operated a two-way network? Thank you.

Nan Hao

Okay. First of all, I will ask Mr. Liang to answer your question.

Operator

And once again, ladies and gentlemen, if you would like to ask a question, please press star then 1 on your telephone.

Nan Hao

First, your first question will be answered by Mr. Dong Li.

Dong Li

(Chinese language spoken)

Nan Hao

First, your first question about the network consolidation and the digitalization projects in China. Currently, the cable operator network consolidation, currently we have more than 20 provinces have completed, finished their consolidation. And for the digitalization project, the majority of the city has completed their digitalization projects, and for the following years the digitalization projects will be developed in tier 3 and 4 [counties].

So, go ahead. Do I answer your question, Philip?

Operator

And once again, if you would like to ask a question, please press star then 1.

We do have a question from the line of Philip Wan with Morgan Stanley.

Philip Wan - Morgan Stanley

Hi. My follow-up question is about your ASP.

Nan Hao

Okay.

Philip Wan - Morgan Stanley

Hello? Can you hear me?

Unidentified Participant

Please continue.

Philip Wan - Morgan Stanley

Sure. Your ASP only declined at 1% in 2011. And what is the reason that you're expecting another 5% to 8% drop in -- coming into 2012? And also, I appreciate if you could share with us your expectation of the unit cost trend this year as well. Thank you.

Nan Hao

Okay.

Dong Li

(Chinese language spoken)

Nan Hao

Okay, Philip, for your ASP questions, there are some reasons cause this 5% to 8% decrease in 2012. The first reason is, as we have already mentioned in the beginning of 2011, we estimated the ASP will have 5% decrease in 2011. So, from the market competition point of view, we have 20% higher ASP price compared to our competitors. So, for 2012, the pressure comes from the price of other competitors. This is one reason.

And the other reason, cause of the decrease of the ASP, because after the consolidation of network cable operator, and the cable operator have some price pressures [for the six] suppliers when they purchased the smart cards. So that's actually the two reasons caused the ASP decrease by 2012.

Philip Wan - Morgan Stanley

Thank you. How about the unit cost trend going into 2012?

Nan Hao

So you're asking about the unit cost trends, right?

Philip Wan - Morgan Stanley

Yes.

Nan Hao

Well, the unit cost will be decreased by around 4% due to the chip cost decrease.

Philip Wan - Morgan Stanley

All right. Thank you. And then my last question, you mentioned that the dividend payment is expected to be paid out at the end of March or early April. I wonder, have you already obtained the appropriate approval from the government at this point?

Nan Hao

Okay, I will ask Mr. Liang to answer this question.

Philip Wan - Morgan Stanley

Thank you.

Zhenwen Liang

(Chinese language spoken)

Nan Hao

We have mentioned the approval progress. The first approval, we need to -- before we pay the dividends, we need to get approval from the foreign exchange authority and --

Zhenwen Liang

(Chinese language spoken)

Nan Hao

So, currently we have already applied for the buying US dollars from the foreign exchange authority. And they will be taking around 30 to 40, no more, working days for their final approval. After that, we can pay the dividends around end of March or at the beginning of April.

So, Philip Wan, did I answer your questions?

Philip Wan - Morgan Stanley

Right. Thank you.

Nan Hao

Okay.

Operator

And once again, ladies and gentlemen, if you would like to ask a question, please press star then 1.

We are approaching the end of the conference call. I will now turn the call over to China Digital TV's Nan Hao for closing remarks.

Nan Hao

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.

Operator

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

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