KongZhong Q3 2006 Earnings Call Transcript

KongZhong Corporation (KONG)
Q3 2006 Earnings Call
November 8, 2006 7:30 pm ET

Executives

J.P. Gan - CFO
Yunfan Zhou - Chairman and CEO
Nick Yang - President
Kingchuen Wong - Senior Vice President

Analysts

Michael Zhang - ThinkEquity Partners
Safa Rashtchy - Piper Jaffray
Li Tang - Pacific Crest
Wendy Huang - Evolution Securities
Jus Lin - Lehman Brothers
Ming Zhao - Susquehanna Financial Group
Wallace Cheung - Credit Suisse
Jim Yin - Standard & Poor's
Chang Qiu - Forun Technology Research
Leah Hao - Thomas Weisel Partners

Presentation

Operator

Good day ladies and gentlemen and welcome to the Q3 2006 KongZhong Corporation Earnings Call. My name is Dupol and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this call is being recorded for replay purposes.

I will now like to turn the call over to Mr. J.P. Gan, Chief Financial Officer. Please proceed, sir.

J.P. Gan

Thank you. Good morning and good evening. Welcome to our KongZhong Corporation third quarter 2006 earnings conference call. You can find our Q3 earnings press release at our website at ir.kongzhong.com. Again, I am J.P. Gan, Chief Financial Officer of the Company. We also have Yunfan Zhou, our Chairman and CEO, Nick Yang, our President and Kingchuen Wong, our Senior Vice President on the line.

I will first go through our third quarter financial highlights. After my discussion, I will turn over to Yunfan, he will review our operations and talk about our business outlook.

Overall, our third quarter financial results are better than what we expected back in August. Our Q3 total revenue increased 24% year-over-year and decreased 17% sequentially to $25 million. The Q3 revenue is about 4% higher than the top end of our revenue guidance provided in August.

Our gross margin in Q3 was about 55%, 2 percentage points lower than the previous quarter. This was also better than our estimates, three months ago. The lower gross margin is primarily due to lower revenue and the fixed nature of certain cost items such as depreciation, server hosting, bandwidth and fixed payment content contract.

In addition we incurred a transmission costs to send SMS, MMS to new users while the subscription is free in initial one-month trial period. The revenue share and payment to telecom operators as a percentage of revenue also increased due to higher proportional revenue from China Unicom, China Telecom and the China Netcom, which on average charge a higher fee.

The total operating expense in the third quarter of 2006 was about $9.8 million, a 3% decrease from second quarter 2006. We continue our efforts to reduce costs and improve efficiency, while investing for the future.

The headcount reduction program has been completed. Our headcount is reduced from over 1,000 in the second quarter to 815 employees as of September 30, 2006. We expect again a cost savings of approximately $500,000, which will be reflected in the fourth quarter financial results.

Our US GAAP net income was $4.8 million. Diluted US GAAP earnings per ADS were $0.14 in the third quarter compared to $0.21 in the second quarter.

Operating margin was 16% and net margin was 19%. Third quarter non-GAAP income was $5.5 million, which exclude share-based compensation cost of about $520,000 and amortization of intangible of 192,000.

Diluted non-GAAP income per ADS was $0.16, down from $0.23 in Q2 '06, but much better than our original expectation. With that I will turn to Yunfan for his remarks.

Yunfan Zhou

Thank you, J.P. As we anticipated due to some regulatory changes from Chinese Telecom operators in the third quarter, our Q2 revenue declined from the previous quarter. However, we are pleased that our revenue exceeded our third quarter revenue guidance. As previously announced we still anticipate challenges in the WVAS business in the remaining of the year; on the other hand, we continue to make progress in our wireless Internet portal business. Although the wireless Internet portal is in the early developing stage, we have begun to see the growth of our mobile advertising revenue. We will continuously invest in the wireless Internet portal, Kong.net and we are confident about its future.

Our Q2 revenue grew 24% year-over-year but declined sequentially to about $25 million, exceeding our Q3 guidance of $23 million to $24 million. Our US GAAP net income was $4.8 million, diluted earnings per ADS were $0.14. Based on the information available by now and after any significant changes in policies of regulation of telecom operators and the Ministry of Information Industry, we expect our Q4 revenue to be between $20.5 million and $21.5 million. In terms of revenue break down from different operators, our revenues from China Unicom, China Telecom and China Netcom accounted for about 25% of the total revenues, compared to this about 23% in Q2. And we believe this retail will continue to grow. In the long-term we believe our diversified operator relationship will help us minimize the risk of depending on a single operator and give us more advantages in preparing for the upcoming 3G services in China.

To summarize, despite a short-term hit of revenue by policy changes in Q3 and Q4, we are confident about the long-term growth of the Chinese WVAS industry in the future. Hopefully with our new products and promotional strategies, and good execution capability, we will resume growth of our wireless value-added service revenue in the first half of 2007.

In Q2 and Q3, we launched our first national marketing campaign for our wireless Internet portal, Kong.net., with the focus of the kong.net brand under the wireless Internet concept. We spent about $1.5 million in Q2 and about $1.2 million in Q3 in the marketing campaign. We put ads on Chinese central television, LCD in office buildings, radios, billboards, buses, subways, in Beijing, Shanghai, Guangdong, and some other major cities in China. We believe this campaign is very successful, by significantly increasing our brand awareness as well as the traffic.

According to a research market survey by [ESPN] which is now the world's largest survey based research group; our Kong.net brand awareness was 34% in Beijing, 24% in Shanghai and 16% Guangdong. We are very happy with these results.

In Q4, we will continue to invest in Kong.net. Although we are facing a difficult time in the WVAS business, KongZhong’s management firmly believes that continuous spending our marketing dollars on Kong.net is the right strategy for us to achieve our vision, which is to build Kong.net to be the largest wireless Internet portal in China. We are making our best efforts to balance, making such investments in our brand, while maintaining profitability.

So to summarize, the two strategic business lines we have, WVAS and wireless Internet portal, are both very important. We believe we have maintained the number two player in the overall WVAS industry in China. Wireless Internet portal is currently in the investment stage, but we believe it will be an important revenue and profit growth driver in one-two-three years time. The Kong.net brand will be our core asset, which will have long-lasting value. Thank you.

J.P. Gan

Okay. With that, we would like to open the line for Q&A please. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Michael Zhang with ThinkEquity Partners. Please proceed, sir.

Michael Zhang - ThinkEquity Partners

Hey, good morning guys.

J.P. Gan

Good morning.

Yunfan Zhou

Hi, Michael.

Michael Zhang - ThinkEquity Partners

Hey congratulations on the good quarter.

J.P. Gan

Thank you.

Michael Zhang - ThinkEquity Partners

J.P., good luck with your new ventures. We are going to miss you.

J.P. Gan

Thank you.

Michael Zhang - ThinkEquity Partners

Just a few quick questions. The first is, the 3Q seem stronger than anticipated. What factors have contributed to these higher revenue and also better margin?

J.P. Gan

There are a few factors. First of all, I think as you probably know, the major issue in the third quarter is so-called free -- one-month free trail period. So, we have been trying to shift a lot of our new customers from the monthly subscription model, to the so-called per download of message revenue model. We have been fairly successful in doing that. Secondly I think as you know, we are very proud of our execution capability. In the last three months, our sales marketing guys have put out more innovative and cost effective marketing methods to acquire new customers, as well as providing the pure customer services to the existing customers, so they don't decide to cancel their subscription after these so-called the second reminder during the quarter.

Michael Zhang - ThinkEquity Partners

Yunfan, you mentioned the transaction-based revenue mottos. What percentage of revenue in 3Q were actually from the transaction base?

Yunfan Zhou

Well, we -- I think, we haven't been disclosing this number. But obviously in the third quarter, the [percentage] of the revenue, that is per message or per download, has been increasing and we have been doing that intentionally.

Michael Zhang - ThinkEquity Partners

Okay

Yunfan Zhou

And it will also go up in Q4.

Michael Zhang - ThinkEquity Partners

Okay. And right now you are forty days into the fourth quarter. How does the trend look like? Is this October battle worse in September? Have you seen any signs of stabilization?

Yunfan Zhou

Yes. This is Yunfan. Actually I already announced we do expect a decline in the Q4 revenue. I think, to add on the J.P.'s comments, I think once we transition from the subscription model to the downloading model from most of our experiences, we face two problems. One is that, we have to spend more marketing sales effort to get the same amount of the revenue for the download, because ARPU is lower. And then second problem is, after that China Mobile has already begun to cancel the inactive users for MMS, WAP and SMS. So, the old subscription revenues will gradually decrease over time. So, these are the new challenges we face. That's why we do give lower Q4 revenue guidance in our earnings release.

Michael Zhang - ThinkEquity Partners

Okay, that is enough. Last one, if I may. You mentioned Kong is going to continue spending on the wireless Internet portal. How much do you expect for 4Q and what's the budget for 2007?

Yunfan Zhou

I think for 4Q, we definitely will -- as already said, we are trying to make the balance of making such investments, while maintaining good level of profitability. So, our spending in Q4 will probably be lower, about $0.5 million lower than the Q3 level. But we're still halfway in the quarter, so we haven't finished making such investments. And, in 2007 we'll definitely continue to make marketing investments in Kong.net.

Michael Zhang - ThinkEquity Partners

So it's going to be about the same level as in 2006 or --?

J.P. Gan

We are still working our budget and the business plan for 2007, so at this point we cannot give you an exact amount.

Yunfan Zhou

And, the year-end [inter-transit] sometimes is obviously a lower spending period for Internet advertising, so we definitely will probably consider this as seasonal. So, next year it may go up higher, the spending.

Michael Zhang - ThinkEquity Partners

Okay. Thank you very much.

Yunfan Zhou

Thank you.

Operator

And your next question comes from the line of Safa Rashtchy with Piper Jaffray. Please proceed, sir.

Safa Rashtchy - Piper Jaffray

Good morning guys. I left the line for a little while, so you might have answered this in a previous question. But I'm wondering, you mentioned that you're pleased with Q3, because the decline in revenue was much better than you had expected. Could you talk a little bit about what contributed to better than expected results and why, despite that, your guidance for Q4 is relatively low? I think I caught the last sentence of your comment that you still expect the higher cost of revenue for long subscription models and also some cancellations impact Q4. But beyond that, anything else you can tell us that can help us look at both sides, Q3 being good and Q4 somewhat cautious guidance?

J.P. Gan

Sure, Safa. There are few factors. First of all, we, as you know, because of the so-called free trial period, we have been trying to shift our customers from the monthly subscription model to per message or per download model. We have been, I guess, doing more successfully than we already expected in the third quarter. And the second, as you know, there has been this so-called reminder to all the existing subscribers. I guess, with our execution capability and superior customer services, our existing customers and subscribers have not churned as much as we originally expected. And that -- those are the major reasons for our Q3 revenue to be better than original expectation. Going into Q4, we'll continue to follow the two methods that we talked; one is to shift to per-message per-download billing model and secondly to provide superior customer services and quality products and hopefully our existing monthly subscribers will continue to stay with us. And in addition we are probably going to start putting more marketing dollars into the market and we are hoping to acquire more and more new customers in the fourth quarter. However given the policy changes deployed, we are still saying that the fourth quarter will be a down quarter unfortunately.

Safa Rashtchy - Piper Jaffray

Okay and the second follow-up, if I may; can you tell us what is your longer term policy, strategy in terms of the mix of subscription type customers versus pay as you grow services? Is it desirable for you to have a large base of subscription customers or do you feel given the current environment form China Mobile, you prefer to minimize that?

Yunfan Zhou

Yeah, this is Yunfan. I think that we definitely will have a mixed strategy on both, promoting subscriptions services and download services. However due to the recent changes in the one-month free trial period, also the double confirmation for SMS from the telecom operators in China, in a more recent terms definitely will promote more download services, in order to get more revenue. However we do believe that, it's best for the company to have a mixed strategy. So, we will first of all [retain] our current channel which include our partnerships with operators, our alliance with the handset manufacturers and also, our media channels to promote both services subscription and download services and secondly, definitely we will try hard to find the new promotion channels to our services and whether its download or subscription, it is still in the trial period, we are still working hard on it.

In the longer term, we believe that subscription services will definitely be better than the download services and we are trying to get more subscription revenue. So, that’s our talk.

Safa Rashtchy - Piper Jaffray

Okay, great. Thank you.

Yunfan Zhou

Thank you.

Operator

And your next question comes from the line of Li Tang with Pacific Crest. Please proceed.

Li Tang - Pacific Crest

Thank you. One longer term question is, once the company has the current stage of this regulation changes, what kind of a [secular] growth rate we can expect for Kong?

J.P. Gan

You mean the revenue growth rate.

Li Tang - Pacific Crest

Yes. I mean if you look at China Mobile data business, it has been growing above 50% a year in the past few years and there seems -- they seems to be confident they can grow that -- their data business about 30% - 25% a year in the next three years. Is that kind of a growth rate that the industry is going to sustain and you can at least in line with that kind of a growth rate?

J.P. Gan

I think first of all the China Mobile data revenue growth rate, I think most of the contribution actually comes from the point-to-point SMS revenue. If you will take a look at the number of SMS sent in China in the past few years, the growth rate is similar to that or even higher than that. And most of that revenue, I think all of that revenue goes to the operator. So, that is I think one of the growth drivers. In terms of the wireless value-added services business, if you look at the big guys like the Internet portals and also Kong, you will see that, for the current quarter and may be for the few quarters going forward the revenues will be in a difficult time. So, we believe that, longer term going beyond the 2007, definitely there will be some new growths drivers in, like the 3G services; in China issued 3G licenses, next year then definitely there are new services opportunities available in the market and we believe the big, the major players in the market will benefit more from the smaller players.

So, right now it's still too early to say how much revenue growth we will have in 2007. However as I said, based on execution and the launch of new products and promotions, we believe we will review growth in the first half of 2007.

Li Tang - Pacific Crest

Okay great and second question is on your wireless portal; when you compare your wireless portal to the offerings from the more traditional Internet portal like SINA, SOHU; what are some of the advantages that you think you have and also when do you think it could become a meaningful contribution to your revenue like, $1 million quarterly run rate, couple of years down the road or what kind of time frame.

J.P. Gan

Yeah I think for Internet portal, first of all we are very confident about our own strength and capabilities. We believe that we are one of the early guys to focus on the wireless Internet portal and today our traffic is, according to our own intelligence, is among the top three in China; already beating some of traditional portals. And our strength specially lies in our gains and communities, in which we had strengths during the past four years in wireless VAS business.

So, and also the branding spending is also another very big thing here. With the spending of these marketing dollars, we believe that we have a slogan put out on the street in China saying that, if you go online with mobile Internet you go with Kong. So, such slogans will definitely give users very clear image of the differentiation of mobile Internet and Internet. So, we believe that, with our execution, our current advantages and current achievement we have made, we are in a very good condition to compete with them in the long run.

And on the other hand, as your second part of the question, the advertising revenue, right now is still small. But we do see the good reception of the wireless mobile advertising by some of the customers. I think it will go through the same pattern as Internet has gone through in the five years ago, the customers will first have to understand, what is wireless Internet and then they will have to use the wireless Internet themselves and later they will put ads on the wireless Internet. So, this is definitely the stages that wireless Internet advertisement revenue has to go through.

So we believe that in the next year or two, especially with the upcoming of the 3G services, wireless Internet advertising revenue will probably really take off and we do expect that to be one of our important revenue growth drivers in a year or two. And we are pretty confident about that.

Li Tang - Pacific Crest

Okay, great. Thank you.

J.P. Gan

Thank you.

Operator

And your next question comes from the line of Wendy Huang, Evolution Securities. Please proceed.

Wendy Huang - Evolution Securities

Hi, good morning. Congratulations on the great quarter; a couple of questions. First is, could you give us some color on how you break the share-based compensation into R&D expense and the G&A?

J.P. Gan

So, Wendy, what was the question again?

Wendy Huang - Evolution Securities

Could you give me the breakdown of the share-based composition cost into the R&D expense and G&A?

Yunfan Zhou

Well, about 70% of our share count is in product development. So the bulk of the share-based compensation costs goes into product development. I don't have the detailed breakdown with me at this point. Can I maybe just shoot you an email later?

Wendy Huang - Evolution Securities

Okay, sure. And the second question is, apart from the $0.5 million cost savings in the G&A due to the headcount decline, could you give some color on other operating expenses. Do you expect some branding expenditures related to the Kong.net?

Yunfan Zhou

Yes, the $0.5 million cost savings is primarily related to the headcount reduction program that we completed. So, it comes from the reduction in overall payroll that goes into different categories; product development, sales and marketing and G&A. Actually it goes mostly into product development and sales and marketing. And also because of the headcount reduction, we return one floor of office space so there is some savings in the rental expense. And also there is related IT product in other expenses. So, that comes to a total of $500,000 that will go into different categories of the expense items.

Wendy Huang - Evolution Securities

What do you expect for the Kong.net marketing strategy going forward?

J.P. Gan

Yes, I already said that, in Q4 we probably will spend $700,000 to $800,000 in marketing expense for Kong.net and going forward in Q1 in 2007, we haven't really had our 2007 budget yet. So, it remains to be seen. But one thing we are sure is that we'll continue to spend on the branding of Kong.net and this turns out to be pretty successful already.

Wendy Huang - Evolution Securities

Okay. My last question is that looking at your balance sheet, your goodwill increased to larger in the past quarter.

Yunfan Zhou

Yes, as you may know, we did an acquisition in the first quarter of 2006 and there are some contingent payments as a result throughout the -- from first quarter to, from third quarter '06 to first quarter '07 and we made the second contingent payment during the quarter and that's why our goodwill went up.

Wendy Huang - Evolution Securities

Okay thank you.

Yunfan Zhou

Sorry, just follow-up on the question you asked earlier about the share-based competition cost; 45% of that goes into G&A and 25% goes into our sales and marketing and about 30 some percentage goes into our product development.

Wendy Huang - Evolution Securities

Thank you.

Operator

And your next question comes though on the line of Lu Sun with Lehman Brothers. Please proceed.

Jus Lin - Lehman Brothers

Hi, good morning everyone. [Jus Lin] on behalf of Lu Sun.

J.P. Gan

Good morning.

Jus Lin - Lehman Brothers

Hi morning. I would have two questions; the first one is will you please give some color on the trends for each of your business lines going into the fourth quarter? And second is how about the margin trends; do you envision some large incremental investments, say on the content side. (inaudible)

Yunfan Zhou

Yes, this Yunfan. I think for the business lines, actually we already gave the guidance for the Q4, I think the revenues from most of the business lines will continue to decline. For WAP services, business it declined about 13% in the third quarter over the second quarter. We believe that is going forward to Q4 it will probably decline for another 10% level.

And MMS will probably be the area that will be hit the most due to the one-month free trial period and also the double confirmation by a lot of the provinces. We right now expect 40% decline in MMS in Q4 over Q3. And for SMS it will continue to decline in mid-teens level in Q4. And for other business lines, Java, color ring back tone, probably a little bit, a slight decline, and IVR also probably mid-teens decline. So, that adds up to our estimates of about total revenue in Q4 will be $20.5 million and $21.1 million.

Jus Lin - Lehman Brothers

Okay.

Yunfan Zhou

And also we believe -- we expect non-China Mobile revenue will grow to be between 25% and 30% in Q4. So, that's our breakdown right now.

J.P. Gan

Okay, this is JP. In terms of margin, again there are a couple of factors. First of all, as our revenue will go down, unfortunately again in the fourth quarter, there are certain fixed costs in our content sales, and especially with the content costs and depreciation of the IT equipment, that will remain to be the same quarter-on-quarter.

And secondly as Yunfan mentioned, the proportional revenue from China Unicom, China Telecom and China Netcom will go up, and those operators on average charge a higher fee than China Mobile. So, because of those two factors we believe our gross margin will continue to go down in the fourth quarter. We, at this point based on information available, at this point we estimate our gross margin will be somewhere between 50 and 52% in Q4.

Jus Lin - Lehman Brothers

Thank a lot. We have a final question, it is on the Kong.net advertising. We noticed, you've made quite a decent progress there. I just wonder what's the major format of your advertising on Kong.net so far; is there many banner or direct ads or with more interactive function there? And what's your major advertiser client base so far?

Yunfan Zhou

Yes, I think in Q3 we made some progress in the mobile advertising. The major format is the text link and also the banner. And also includes the MMS direct sending to the customers. So, these are the major formats. And we are working on creating a more richer content or interactive format for the advertisers. We are -- easily, we are now the pioneers in doing mobile advertising in China. So, the future is quite open. So, we are -- it's all about how we create a new format. And the major advertisers in Q3 include Motorola, BMW and Lenovo, so, still just the large players. Right now we only have a few sales people; we are also increasing the number of sales we have. So, we do have confidence in growing our mobile advertising revenue.

Jus Lin - Lehman Brothers

And from which industries you see advertisers have high demand for your current advertising?

Yunfan Zhou

Right now I think from -- a lot of advertiser enquiries are from the cell phone industry because they know what mobile Internet and they do use mobile Internet themselves. As I said before, advertisers, they have to first understand the concept and then they have to use the mobile Internet themselves before they place any advertising on it. So, these are the three-stage process will have to be completed before there are a lot of advertisers. So, right now I believe that going forward, it will still be the IT industry that'll be the first spenders for the mobile advertising.

Jus Lin - Lehman Brothers

Okay, great, thanks.

Yunfan Zhou

Thank you.

Operator

And your next question comes from the line of Ming Zhao with Susquehanna Financial Group. Please proceed.

Ming Zhao - Susquehanna Financial Group

Thank you, good morning guys.

J.P. Gan

Good morning.

Ming Zhao - Susquehanna Financial Group

Just one question; you said that you expect the revenue to grow again in the first half of '07. My question is, do you expect some positive policy change down the road that could contributed to that or is it just your better execution that make you believe you will get there?

Yunfan Zhou

Right now we don't see any new major policy changes from the operators. And our estimation right now depends how our own internal estimates of different business lines and also our new products and offerings and new channels and our execution. So, that after any, the current estimate is after any major policy changes.

Ming Zhao - Susquehanna Financial Group

So, when you say the first half of '07, that's first quarter or the second quarter?

Yunfan Zhou

Probably either; so we -- right now we don't have any firm numbers for the next two quarters yet.

Ming Zhao - Susquehanna Financial Group

Okay, thank you.

Yunfan Zhou

Thank you.

Operator

And your next question comes form the line of Wallace Cheung of Credit Suisse. Please proceed.

Wallace Cheung - Credit Suisse

Hi, good morning Yunfan and JP. Good quarter.

J.P. Gan

Good morning.

Wallace Cheung - Credit Suisse

Yes, two questions, first of all, just simply can you comment a little bit on the month-on-month sequential trend of first quarter? Just want to understand, if the relatively low fourth quarter guidance relate to the maybe relatively weak September monthly revenue? So that is the first question. Second question is, we have the one-month policy in third quarter, and operators let it in, I think it's at the end of September, and they have the full implementation, double confirmation, in fourth quarter. I mean, net-net -- and you still have a relatively big fourth quarter. So, can you just do a little more -- maybe comment on how the change of policy impact on the revenue? Thank you.

Yunfan Zhou

This if Yunfan. I think the policies -- the major policy changes included the one-month free trial period and the double confirmation and cancellation of inactive users. So, I think these three are the major policy changes. In terms of different business lines, (inaudible) for that, we already switched our WAP -- most of our WAP services into the download model. So, the biggest impact comes from the one-month free trial period. So -- but the download model definitely tends to a little bit lower ARPU than a subscription model. And also the cancellation of the format inactive users, that also hit the existing subscriptions. So, that's why we are expecting about 10% decline in WAP revenue in Q4 over Q3. And that's what we have seen going in October so far as well. The good news on the WAP is that, right now China Mobile, they have recently -- just in the last two days, they have just announced -- they have announced the results of the bidding for the nine premium channels for WAP. So that means they will open nine premium channels on Monster Net on different levels, including the top menu and the second menu, and we got two of the nine. So that's good news for us. We got one music channel and one game channel. So, we believe that these new channels will probably be online sometime in December this year. So, the revenue we don't expect much from these premium channels in Q4, but we do feel it will have a positive impact on our WAP and Java revenue in next year. So, for MMS and SMS, I think the major challenges come from the one-month free trial period and the double confirmation. For SMS, we -- I believe that almost all the local operators of China Mobile and most of the operators from the other, China Unicom, China Telecom, Netcom, they have implemented the double confirmation rules. So, that will be a very big shift to our revenue, because most of the spendings dilute the spendings. So, the double confirmation will give the users very big hurdle to make their spendings. And so we have switched some part of our services to the download model for SMS and that will also hit the revenue in Q4. And for MMS, a lot of -- I think so far seven provinces are -- have implemented the double confirmation, and the rest actually implement the one-month free trial period. So, we do expect more provinces will implement the double confirmation policy, and that will further hit the MMS revenue. And so we do expect a major decline in MMS revenue in Q4. So, I think that probably gives you some insights of different business lines in Q4.

Wallace Cheung - Credit Suisse

And sorry, about my first question on the monthly sequential trend. Actually my question would be saying, have you seen the worst already happened maybe in September or even in October that we are getting to be -- have a relatively better maybe November and December?

Yunfan Zhou

The revenue actually goes down. And the reason is, as I stated before, the reason is that introduction of the download model will generate a little bit lower ARPU, and at the same time, the cancellation of existing inactive subscriptions will result in a lower revenue base for the subscription revenues. So, we believe that the SMS, MMS will probably gradually decline -- the revenue will gradually decline month over month until you reach this stability level.

Wallace Cheung - Credit Suisse

Just a final question is, I think recently there's some news saying China Mobile is actually trying to work much closely with something, like, [optimal] SPs. Actually do you see maybe after the National Day, that they're more positive now in the cooperation gesture working with all you guys?

Yunfan Zhou

Do you mean the China Mobile partnership and the top SPs?

Wallace Cheung - Credit Suisse

I think they've been holding some meetings with major top tier SP like [ODSV] couple of months ago. And I think the last two months I think Guangdong province, they have also talking with some of the top SPs as well. Does it mean, like, China Mobile actually tries more positive work with SP in the future?

Yunfan Zhou

Yes, I think, now the good gestures we already got is, the WAP premium channels we already explained to you. So I think three -- the nine premium channels goes to about six SPs, and most of them are large SPs, including Kong, and we got two of them. And some other major SPs got one or two channels. So, I think that's a gesture that China Mobile wants to partner more closely with the top tier service providers.

Wallace Cheung - Credit Suisse

Thank you very much.

Yunfan Zhou

Thank you.

Operator

And your next question comes from the line of Jim Yin with Standard & Poor's. Please proceed.

Jim Yin - Standard & Poor's

Thank you. Good morning.

Yunfan Zhou

Good morning.

Jim Yin - Standard & Poor's

You say you're not sure if your revenue will accelerate in the first quarter, second quarter. If revenues declines further in Q1 from Q4, do you plan to do a further headcount reduction?

Yunfan Zhou

Right now, we haven't really thought about that, because our best estimate is that our revenue will continue -- will resume growth in Q1. So if that happens, definitely we don't want to consider more headcount reduction. And so, as I said, if the first half of 2007, is still a little bit not clear yet.

Jim Yin - Standard & Poor's

Okay.

J.P. Gan

This is J.P. I think, we believe that our revenue will resume growth definitely in first half of 2007. But we're not sure which quarter -- in which quarter we'll see a spike. But in worse case scenario, we think in Q1 2007 the revenue level will stabilize, and hopefully there will be some growth in Q1.

Jim Yin - Standard & Poor's

Okay. And also one last question, you plan to buy -- repurchase any shares?

Yunfan Zhou

I think we are -- the shareholders have authorized the Board to for a shareholder buyback plan, if the Board considers appropriate. Right now we are still considering that, but we haven't got any specific plans yet.

Jim Yin - Standard & Poor's

Okay, thank you.

Yunfan Zhou

Thank you.

Operator

And your next question comes from the line Chang Qiu with Forun Technology Research. Please proceed.

Chang Qiu - Forun Technology Research

Hi, this is Chang Qiu. Good morning J.P. and Yunfan.

Yunfan Zhou

Good morning.

Chang Qiu - Forun Technology Research

Yes, one question for you. Looks like you've got a few good mobile games and where you think your (inaudible) will start to increase.

Nick Yang

Yes, Nick, I'm President for the company. Mobile games has always been a core strategy for our company, especially in our -- with our vision over the wireless Internet being very, very popular in the future. And I believe that with the advent of faster download such as Edge, such as the upcoming 3G era, I believe, the wireless gaming, both download model and the online model, will see a positive boost with the faster download. So, we're very positive on the online game asset, and we have always been the leader in mobile gaming in the China's wireless space.

Chang Qiu - Forun Technology Research

Okay, that's great. And another question for your wireless Kong.net portal. In terms of environment, it looks like there are quite many other free WAP site, and looks like their valuation probably like the public peers is way down. Do you or have you considered to buy some of them to increase your critical mass in a much quicker way?

Yunfan Zhou

Yes. I think we are looking at some of the players today, and among the criteria we have is that it must be complementary to what we have right now. I think it's still in an early stage, and the traffic actually goes to the top 10 large players. They actually are probably 70, 80% of the total free WAP traffic. So other than that, the smaller players, they probably won't be -- add much to our core competence. At the same time, we are looking at how these smaller players, how these probably five to 10, how these players are working out. So, we do look at them and we haven't got any specific target yet. But if there's any that's appropriate we'll definitely consider invest or acquire.

Chang Qiu - Forun Technology Research

Okay. All right, great, thanks.

Yunfan Zhou

Thank you.

Operator

And your next question comes from the line of Leah Hao with Thomas Weisel Partners. Please proceed.

Leah Hao - Thomas Weisel Partners

Hi, good morning, guys. First of all, J.P., congrats on your new job and best of luck. I have three questions actually. MII policy regarding the double confirmation outside of China Mobile has been implemented since middle of October, and I was wondering if -- what kind of impact you guys have seen so far? And secondly, there are 3G, initial test of 3G TDS-CDMA in four cities in China. I was wondering what's your view regarding the 3G timeline as well as impact at this point? And lastly just little bit housekeeping item. You mentioned there is a headcount reduction charge in Q3 on the R&D line, and I was wondering what's the amount? Thank you.

Yunfan Zhou

Yes, I think the double confirmation policy actually gradually implemented by different local operators of different telecom operators. So we do see a gradual decline in the revenue in SMS and MMS due to the implementation of these policies. And so for estimates, I think most of the provinces and operators have completed launching the double confirmation. For MMS is still in the early time, only a small number of provinces have implemented that policy. So, we do believe in the next few months we'll see gradual decline in the revenue due to the double confirmation policy and our shifting to the download revenue model for some of the services. So, hopefully that answers the first part of the question. And the second, regarding to the 3G. We have been quite active in partnering with different operators on the 3G projects. We have internal team of about 10 people working on 3G for the past one year and a half already. So, we believe that China will probably issue the 3G licenses in 2007. And, we are definitely very welcome the 3G, and we have made a lot of preparations for 3G. So, hopefully that'll the new opportunities for us to grow our revenues again. And for the third part, J.P., if you want to answer.

J.P. Gan

Sure, yes. The headcount reduction program was announced in late July, and completed in August. So, we have to pay some severance to the unfortunate layoff. However, the reduced payroll is reflected partially in August and completely reflected in September. So, net-net of the third quarter product development expenses is only slightly higher than the previous quarter. And the total payment to -- the severance pay is about $250,000. And the saving obviously will be reflected in fourth quarter completely.

Leah Hao - Thomas Weisel Partners

Great, thank you. A quick follow-up, if I may. So, I was just wondering, what your full year '07 outlook for either the industry or Kongzhong's revenue growth, if you will? Thank you.

Yunfan Zhou

We'll be talking about that in the fourth quarter earnings announcement. Give us some more time, Leah.

Leah Hao - Thomas Weisel Partners

Okay, thanks.

Operator

And your final question comes up as a follow-up from the line of Michael Zhang with ThinkEquity Partners. Please proceed.

Michael Zhang - ThinkEquity Partners

Just a quick follow-up. I know China Unicom is going to finish its GSM network upgrade by end of the year, and I think 2.5G services will be available on the G network early next year. But do you guys see any growth opportunities from China Unicom?

Yunfan Zhou

Yes, we do.

Michael Zhang - ThinkEquity Partners

Okay, how big it will be?

Yunfan Zhou

I think with completion of integration with Sure Patch, we already have some presence, a good presence in Unicom. We believe that we have a strong capability to grow our revenues in the Unicom. However, as you know, the Unicom also implements double confirmation policy. So, it's still -- there's still a tough environment there, similar as the China Mobile environment. So, we do believe that there are more opportunities for us in China Unicom in the near term, as we have a bigger team working on the Unicom product.

Michael Zhang - ThinkEquity Partners

Okay, thank you.

Yunfan Zhou

Thank you.

Operator

And there are no more questions in queue at this time. I will now like to turn the call over to Mr. Gan for closing remarks. Please proceed, sir.

J.P. Gan

Okay, thank you. Thank you, I would like to thank everybody for calling in. I would also personally like to thank everybody for your support in the past year and a half. I'll look forward to speaking with you as a CEO again.

Yunfan Zhou

Yes, this is Yunfan, just want to make one more remark. On behalf of Kongzhong Company, I would like to thank J.P. for his service to Kongzhong. He has mad a lot of contribution to our company. And so, we wish him all the best in his future career. Thank you very much.

J.P. Gan

Thank you, Yunfan. That will conclude our third quarter 2006 earnings conference call. Thank you. Bye-bye.

Yunfan Zhou

Bye-bye.

Operator

Thank you for your attendance in today's conference. This concludes your conference call. You may disconnect. Good day.

Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.