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

Q2 2012 Earnings Call

August 21, 2012, 8:00 pm ET

Executives

Dong Li – President

Nan Hao - Head of Investor Relations

Josh Gartner – Brunswick Group

Operator

Good evening and thank you for standing by for China Digital TV’s second 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. I would now like to turn the meeting over to your host for today’s conference, Mr. Josh Gartner.

Josh Gartner

Hello everyone and welcome to China Digital TV’s second 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, 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.

I’d like to begin by sharing some updates on recent trends in China’s cable market. As cable network consolidation continues to move toward completion, we are seeing purchasing decisions increasingly being centralized at the provincial, rather than sub-provincial, level. As a result of this change, during the second quarter, we experienced some industry headwinds, primarily due to delayed purchases from a few provinces. However, we believe that the unmet demand for smart cards in these provinces will be fulfilled at a later stage.

In the second quarter, our shipment volumes were impacted by the industry-wide purchasing delays that I just mentioned. During Q2, smart card shipments were 3.74 million, compared with 4.64 million in the same period in 2011 and 3.70 million in the first quarter of 2012. During the second quarter, average selling price, or ASP, for smart cards decreased by 5.4% compared to Q1 2012. We maintain our expectation that ASP on an annual basis will be 5 to 8 percent lower this year compared with last year. In addition, the unit cost for smart cards decreased by 4.1% compared to the first quarter of 2012.

Despite industry headwinds in the second quarter, we remain confident in the long-term growth drivers of China’s cable sector. There are several trends that we believe give us reason to be optimistic about the sector going forward.

First of all, cable development and digitalization are progressing steadily. As of the end of Q2, 202 million households in China have cable. Within this group, about 125 million or 62% are digital cable TV subscribers, with 5.5 million households being added in the second quarter. We expect this growth momentum to continue over the next few years.

Secondly, in Q2, we saw a steady push for digital penetration in lower-tier cities and rural areas. We performed particularly well in Jiangsu, Heilongjiang, Guangdong and Shandong, which enabled us to maintain our leading position with a 58.4% share of China’s CA market, according to Zhongguang Luoda.

Third, looking ahead, the previously discussed trend of CA product purchasing decisions being made at the provincial level leads us to expect to see contracts in larger volumes from provincial cable operators. Specifically, in the first half of 2012, we signed framework contracts to provide smart cards to provincial or municipal cable operators in Sichuan, Henan, and Chongqing. Among the three networks, Sichuan and Chongqing cover 5 million cable households and 3 million terrestrial TV households, respectively.

Finally, in the near future, we expect the conversion from standard definition set top boxes to high-definition set top boxes will become a driving factor for demand of our CA products.

Beyond the traditional domestic market for our CA products, in Q2 we continued to make progress in international markets. We delivered another 380 thousand mounted device chipsets to our partner One Sky in Thailand during the quarter, bringing total shipments to date to almost 1.7 million units. We also received another mounted device chipset order of 500 thousand units from One Sky this quarter. Going forward we expect steady demand from this program. In Q2, China Digital TV also fulfilled its agreement to deploy a Malaysian ABN TV Station with CA head end systems and provide licensor software.

Another bright spot during the second quarter was the revenue growth from our other products, including our advanced multimedia home entertainment boxes, and surface mounted device chipsets. Emerging and growing demand for these products helped China Digital TV partially offset the impact of the delayed purchases in other areas. In Q2, revenue from other products reached 4.1 million US dollars, compared with 293 thousand US dollars for the same period last year. Sequentially, revenue from this category of products nearly doubled.

We have also been very pleased with the encouraging progress we achieved from our value-added services this quarter, which is part of our diversification strategy to expand our revenue sources.

As we previously discussed, China Digital TV has deployed a cloud computing system in Nanjing city, which includes 1,000 concurrent nodes. Following the completion of Beta testing, the platform was officially launched in Nanjing in July, covering a user base of 180 thousand. We believe that our cloud computing system will increasingly become a platform to provide variety of applications to subscribers, including online gaming, stock trading and education applications. This platform already currently supports 49 applications, and we anticipate that it will grow significantly over the next several quarters. We are currently actively seeking additional partnerships with cable and telecom operators in other cities and provinces to duplicate the initial success of this program.

Our next generation home entertainment box product developed by Joy See has also made encouraging progress and we began shipments for these Microsoft-compatible Home Entertainment Boxes in Q2. Currently, it comes with more than 20 applications installed, with another 100-plus applications available for download from the app store.

Separately, China Digital TV has partnered with local cable operators to provide video-on-demand to viewers at home. Under our agreement, China Digital TV provides the platforms for subscription and digital rights management of the content. We currently offer films on a free basis as part of our trial operations in 8 cities. Meanwhile, in Zibo, Shandong, and Chengde, Hebei, the program has already commenced commercial operations and has begun charging for content.

I would also like to take this opportunity to discuss the development of China Mobile Multimedia Broadcasting, or CMMB, a home-grown standard for mobile TV broadcasting in China. Under the CMMB scheme, China Digital TV is one of the two CA systems providers selected by China Satellite Mobile Broadcasting Corporation or CSM. We are currently the only domestic provider, and in the second quarter, China Digital TV reached an agreement with CSM to supply 1 million surface mounted device chipsets. We anticipate shipments will occur either later this year or in early 2013.

As we look toward the future, China Digital TV remains focused on exploring emerging market trends relevant to our core CA business, both in China and in select global markets. At the same time, we will also keep investing in research and development to create next generation products and service solutions to capture further 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.

We were able to partially offset the impact on revenue of a challenging quarter throughout the industry with growth from our other products, including multimedia home entertainment boxes and surface mounted device chipsets. While we remain confident in the long-term development of China’s cable industry, we anticipate that smart cards sales may continue to be impacted by these headwinds in the coming quarters. As a result, we believe that our annual shipments for the year will be around 15 million.

I will now turn to the financial highlights for the second quarter of 2012. Please note that, unless stated otherwise, all amounts are in US dollars.

In Q2 2012, China Digital TV shipped approximately 3.74 million smart cards, compared to 4.64 million for the same period in 2011 and 3.70 million in the Q1 2012.

Net revenues in Q2 2012 were 23.5 million, a decrease of 5.0% from the same period in 2011 and an 8.0% increase from Q1 2012. The year-over-year decrease was primarily due to a decrease in the shipment volume of smart cards, and was partially offset by an increase in the sale of other products as mentioned earlier. The quarter-over-quarter increase in net revenues was primarily due to an increase in the sale of other products.

Now let me go through the major revenue components for the quarter.

Revenues from smart card sales were 18.2 million, accounting for 76.5% of total revenue, a 5% decrease quarter-over-quarter. As Mr. Li previously mentioned, some provinces delayed smart card purchases.

Revenues from other products were 4.1 million, accounting for 17.2% of total revenue, a 95% increase quarter-over-quarter. Revenue growth was largely due to sales of multimedia entertainment boxes.

Revenues from our top five customers accounted for 27.8% of total revenues, compared to 22.7% in Q1 2012.

Gross profit in Q2 2012 was 17.9 million, a decrease of 10.9% from last year and an increase of 6.1% from Q1 2012. Gross margin was 76.4% in Q2 2012, compared to 81.4% in Q2 2011 and 77.7% last quarter. The year-over-year and quarter-over-quarter decreases in gross margin were primarily due to decreases in revenue from smart cards sales and increases in the costs of other products. The gross margin of smart card sales remained steady. However, the revenue from other products significantly increased to 17.2% from 1.2%, of total revenue. These other products have lower margins than our smart cards, which accounts for the overall decrease in gross margin.

ASP of smart cards in Q2 2012 decreased by 5.4% sequentially, while unit costs decreased by 4.1%.

Operating expenses in Q2 2012 were US$10.5 million, an increase of 38.4% from the same period in 2011 and an increase of 20.2% from Q1 2012.The year-over-year and quarter-over-quarter increases were mainly due to increases in marketing activities on new product promotion, and the increased headcount of our R&D and sales and marketing staff.

Income from operations in Q2 2012 was 7.4 million, a 40.9% decrease from last year and a 9.1 % decrease from last quarter. Operating margin in Q2 was 31.5%, compared to 50.6% in the same period in 2011 and 37.4% in Q1 2012.

Income tax expenses in Q2 2012 were 1.8 million, a decrease of 29.2% from the same period last year and a decrease of 19.4% from Q1 2012. The year-over-year and quarter-over-quarter decreases were largely due to a decrease in taxable income.

Net income attributable to China Digital TV Holding Co., Ltd., in Q2 2012 was 7.1 million, a decrease of 37.0% from the same period in 2011 and an increase of 2.5% from Q1 2012.

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 Q2 2012 was 8.0 million, a decrease of 36.5% from the same period in 2011 and a decrease of 1.6% from Q1 2012.

Turning to our balance sheet...

As of June 30, 2012, China Digital TV had cash and cash equivalents and restricted cash totaling 180.4 million. In Q2 2012, cash flow generated from operations was approximately 9.2 million.

Now, let me provide you our business outlook.

Based on information available as of August 21, 2012, China Digital TV expects smart card shipments for Q3 2012 to be in the range of 3.5 million and 3.8 million. Net revenues for Q3 2012 are expected to be in the range of 20.6 million and 22.1 million.

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

Question-and-Answer Session

Operator

(Operator instructions) There appear to be no questions in queue, I will now turn the call over to China Digital TV’s Hao Nan for closing remarks.

Hao Nan

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.

Operator

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

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