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TOM Online, Inc. (NASDAQ:TOMO)

Q3 2006 Earnings Call

November 9, 2006 7:30 am ET

Executives

Rico Ngai - IR

Wang Lei Lei - CEO

Jay Chang - CFO

Analysts

Michael Zhang - ThinkEquity

Safa Rashtchy - Piper Jaffray

William Bean - Deutsche Bank

Catherine Leung - Citigroup

Richard Ji - Morgan Stanley

Ming Zhao - Susquehanna Financial Group

Li Tang - Pacific Crest Securities

Tian Hou - Unterberg Towbin

Wallace Cheung - Credit Suisse

Adam Clark - Bear Stearns

Kit Low - Goldman Sachs

Lin Chi - Lehman Brothers

Operator

Good day everyone and welcome to the TOM Online Investors 2006 Third Quarter Results Conference Call. For the duration of the presentation, all lines will be placed in listen-only mode. (Operator Instructions). And I would like to hand the call over to Mr. Rico Ngai and I will be standing by for the Q&A session. Please go ahead. Thank you.

Rico Ngai

Thank you. Good morning and good evening, everyone. Welcome to TOM Online results investor conference call for the third quarter of 2006. Joining me today are our CEO, Mr. Wang Lei Lei and our Chief Financial Officer, Mr. Jay Chang.

Slide presentation of this conference call is available through our investor relations website at http://ir.tom.com.

Before the management presentation, I would like to bring attention to the safe harbor statement in connection with today's conference call. During the course of this conference call, we may make forward-looking statements that are not historical facts, including those about our beliefs and expectations. Forward-looking statements involve inherent risk and uncertainty. A number of important factors could cause actual results to different materially from those contained in any forward-looking statement. Further information regarding these and other risks is included in TOM Online's annual report on Form 20-F for the year ended December 31, 2005 as filed with the Securities and Exchange Commission in the US.

Following management's prepare remarks, we will open the line for a brief Q&A session. Now let me turn the call over to our CEO, Mr. Wang Lei Lei.

Wang Lei Lei

Thanks Rico. Good morning and good evening and thank you for your continued interest in TOM Online. Despite difficult operating conditions due to the new policies implemented this quarter, I am very pleased to report TOM Online continuing to demonstrate our leadership in China Wireless Internet market, achieving total $8.95 million in total revenues for the third quarter and over $6 million US in adjusted net profit.

Total Wireless Internet revenues were $34.7 million and online ad revenues were $3.53 million. Based on these results, we remained the number one wireless service provider in mainland China and exceeded the high end of our guidance by over 12.

Over to page 5, upon learning about the new policies earlier this year, we made early efforts to adjust our business to more depressed operating environment. Through our teams hard work and better than expected response from the end users, the impact to our business was not as bad as we had originally expected.

Looking forward, while the regulatory environment appears to have stabilized; the operating environment remains difficult. We, however, begin to see signs of industry consolidation as smaller players exit the market. More importantly, we would believe China Mobile's strategy in the future will be depended more closely with the few selective service providers such as TOM Online, to develop the bulk of value-added services market. And we believe they will stop doing this on their own or working with hundreds of partners as did in the past.

For example, we were originally selected by China Mobile to be one of their primary partners to fully offer key components of their WAP portal. Beginning at the end of this year, we will operate the two out of nine channels on China Mobile's WAP portal including their music auto channels under the same revenue sharing model, which is 85% to 15%. Only two other service providers were awarded two categories and only total six companies were selected as a part of these new China Mobile strategic partner and also demonstrating that the wireless market will become more and more concentrated around a few strong players. In addition, at the Guangdong province China Mobile has implemented new policies where the top ten service providers, including TOM Online, will benefit by having preferred access to new service channels. like [STK] bundling and closer integration with local marketing programs. So as you can see, while the near-term decline of our business has being disappointing, we remain optimistic that TOM Online has the ability to emerging even strong market positions and before the new policies were implemented. While it is still difficult to foresee, we continue to believe the wireless internet will be the primary way Chinese users access to digital information and the payment of services in the future and also believe TOM Online is well positioned to lead the market in this area.

As I just mentioned, we believe there are many opportunities to leverage our resources, to enable the Chinese mobile operators to better serve their large user base and we believe our ability to innovate, understand the young market and integrate the WAP to the mobile phone makes TOM online a valuable partner to carriers. We hope to demonstrate this over the course of the next year through determined execution. Plus also look for us to have particularly develop our new services and products in the mobile area. We continue to work with UMPay on mobile payments and we expect mobile advertising and mobile commerce to new areas to develop into ’07 and beyond.

Let's go to the page 6. During the quarter we have begun to see our TOM-Skype user base grow at a much faster pace as we have optimized our marketing programs but more importantly we believe the TOM-Skype community is beginning to reach critical mass and actually positive network effect. At the end of October we have 23.5 million TOM-Skype registered users, an increase of over 8 million from the end of July or an average of nearly 100,000 new registered users per day during this period. We believe this growth rate placed TOM-Skype near the market leaders in terms of the new data users for IM service in China market. However the total size of the TOM-Skype community is too small compared to the market leader. We believe it's more important to continue to focus on user acquisition at this early period for TOM-Skype. As such well we do expect to begin to monetize Skype in early 2007 manage through advertising. We will hope it could be more meaningful in the second half if the user growth continues.

Turning to our portal, our advertising business declined slightly in 3Q due to a seasonally strong 2Q and we expect our 4Q to be relatively slight as we position for 2007. We continue to see good growth on our portal in various user-generated contents like Huan Jian Shu Meng which is the online literature and Wanleba which is the musical community and intend to dedicate more resources to our portal team to position TOM Online as a leading entertainment site in China's online market. Now I would like to turn the call over to Jay to discuss our financial overview.

Jay Chang

Thanks, Lei Lei. Total revenues for the third quarter was $38.95 million dollars, a decrease of 15% roughly year-on-year and 22% quarter-on-quarter. Wireless internet revenues made up roughly 89% of total revenues, that's 34.71 million, a decrease of roughly 20% year-on-year and 24% quarter-on-quarter. Online advertising revenues made up 9% of total revenues, up from roughly 7.8% last quarter and declined 9.2% quarter-on-quarter but were still up 36% year-on-year. Overall gross margins were 33% down from 38% in the second quarter as a large portion of our cost of services are fixed in nature such as salaries, depreciation, bandwidth and other costs. This translated into 3Q gross margins for the wireless business in the high 20 to 30% range and the mid 50% range for online advertising. The lower online advertising gross margin from the third quarter reflects additional expenses related to rich a media platform fees and the shift in how we allocate common costs based on revenue mix.

Our adjusted EBITDA for the third quarter which excludes stock-based compensation of roughly $740,000 -- $7.5 million, demonstrating that despite difficult operating conditions we were still able to stay at a healthy level of cash flow. Net profits for the third quarter was 5.3 million and although net profit does include an exchange gain of roughly $740,000 due to the appreciation of RMB upon translation of our net non-RMB liabilities. Adjusted for stock-based stock based compensation charges, adjusted net profit was just over $6 million or roughly $0.11 per ADS.

We turn to the next page which is page nine if you are following the presentation. Due to the new policies implemented during the quarter, our wireless internet business was negatively impacted but offset by first full quarter of consolidating Infomax. Beijing Infomax, which the company we acquired in June that has exclusive right to CCTV-2.

In 3Q, Infomax contributed roughly $6.95 million in total wireless revenue -- internet revenue, made up roughly 20% of our total wireless revenues. Majority of these revenues for Infomax were SMS based as well as usage based. And revenues from the Dream China program, which was -- the show was broadcast in the August and September time frame made up roughly 40% of Infomax's total revenues in the quarter.

In terms of our revenue mix between Unicom and China Mobile, we generated over 20% from Unicom in the third quarter compared to around the 50% level in previous quarters. There is more details in the press release of the line by line item in terms of SMS, MMS, WAP, IVR, Colour Ringback Tones, and I please ask listeners to take a look at that for more details on a line by line basis.

Turning to page 10. Total operating expenses in 3Q were $8.55 million, compared to $8 million in the second quarter. The slight increase in operating expenses reflects additional costs related to the consolidation of Infomax and their G&A costs as well as associated amortization expenses associated with Infomax. We maintained our sales and marketing spend compared to the second quarter as we continue to invest in our portal brands and as well as TOM Skype marketing activities. As such, 3Q operating profit was $4.22 million with operating margins of 10.8% compared to 22% in the second quarter due to policy impact.

Turning to page 11. Lastly for some housekeeping, we exited the quarter with roughly $136 million of total net cash in our balance sheet compared to $122 million in the prior quarter. This increase was really reflected from free cash flow as well as improvement in AR and as well as the appreciation of RMB.

Lastly turning to page 13 of the presentation, our 4Q guidance. We expect total revenues to be in the range of $34.5 million to $35.5 million, which represents a roughly 8.8% to 11.4% sequential decline from the third quarter. This guidance implies roughly flat quarter-on-quarter performance from our online advertising business as Lei Lei just mentioned and wireless would be roughly down 10 to 13%.

But please note that the 10 to 13% is predominantly the impact as the bulk of this client reflects the Dream China, which was a seasonal 3Q event and such excluding Dream China, would expect the wireless business to be basically stable to only slightly down in the fourth quarter from the third quarter as we have seen our business stabilize relative to the overall new policy environment.

We also expect our operating structure to be remained relatively stable for the quarter. As such, we expect gross margins to be basically flat in the 33% range and operating margins to be relatively flat to slightly down from the 10.5% range on the US GAAP basis.

On that, operator we are ready to take questions.

Question-and-Answer Session

Operator

At this time we will open the floor for questions. (Operator Instructions). Our first question will be coming from Michael Zhang from ThinkEquity. Please go ahead.

Michael Zhang - ThinkEquity

Hey, good evening Lei Lei and Jay.

Jay Chang

Hi Michael.

Michael Zhang - ThinkEquity

Hey congratulations on the strong quarter, a few quick questions, 3Q was much stronger than your guidance. Other than the Infomax, what other factors have contributed to the results?

Wang Lei Lei

There are two reasons. One reason is [level] relation impact is not fully executed for the subsidiary of the China Mobile. Please, then would like some reminder message policy to the existing non-active users is not fully active in the provincial-based carrier. The other reason is regarding Dream China. We acquired a company, Infomax, they have a very high season income from the TV channel, which is about 40% of their total revenue.

Michael Zhang - ThinkEquity

Okay. And look at the guidance, we assume October is weaker sequentially. When do you expect to see the true stabilization on the Q-on-Q basis?

Jay Chang

Actually Michael if I -- if you exclude the contribution from Dream China, and if we look at our business on a month-to-month basis, which is what we do internally, but actually excluding the Dream China, our business was basically stable from the kind of August/September period being a bottom and October being relatively stable relative to the September period.

Michael Zhang - ThinkEquity

Really? Okay. That's great. And how much revenue do you expect from Infomax in 4Q?

Jay Chang

We expect the contribution to be much, much less given the Dream China is over. So in the third quarter it was roughly 20%, I mean roughly it would be about 40% of the -- of Infomax's business would basically be gone in the fourth quarter.

Michael Zhang - ThinkEquity

Okay. And --

Jay Chang

It is going to be flat fourth quarter.

Michael Zhang - ThinkEquity

Okay. And lastly, about the IVR services, we've heard several IVR providers, who have switched to the [Goyan] platform in this quarter, which does not mean a bad thing because the capacity will be much bigger. So just wondering if you guys will do the same eventually, do you have any plans?

Jay Chang

Well, we don't have any firm plans right now because we actually haven't received anything formal from China Mobile. But we have, obviously, been discussing this with them. And at the appropriate time then we can talk about those plans and potential impact as we get more official notice or plans from China Mobile.

Michael Zhang - ThinkEquity

Okay. Thank you very much. Good quarter.

Operator

Thank you, sir. Our next question will be coming from Safa Rashtchy from Piper Jaffray. Please go ahead.

Safa Rashtchy - Piper Jaffray

Hi. It's Safa Rashtchy. Hi guys. Congratulations. Great quarter. Couple of questions. Can you give us a little bit more color on your -- how each areas of wireless did versus your expectations especially on SMS without Infomax, was that in line with your expectation or was there some variation?

Jay Chang

So, line by line, SMS would have been down without Infomax closer to the 45% to 50% range. That's basically inline with our expectations given that half of our China Mobile business going into the quarter was per-message-day subscription. And that obviously got fully cancelled. But that's somewhat in line. I think the area that did slightly better than we expected in terms of the business line was WAP. Going into the quarter we have probably 75% plus of our web business was subscription-based. But going in July, obviously, as we knew about the policies, we proactively shifted our web business to more usage-based to take advantage of our asset channel partners, our TV channel partners, so on and so forth.

The usage-based services actually did a lot better than we had thought. And WAP, although it was up quarter to quarter, that includes some contribution from Infomax, it was down 10% to 15% quarter-on-quarter excluding Infomax. So that was an area that actually did much better than we expected given, I think, -- and that was the mention that that Lei Lei did in his prepared remarks relative to how some of our users responded better to some of the policies.

But obviously IVR was down roughly about 35% quarter on quarter. And that still due to the cross selling suspension which exists in still the most the provinces today.

Safa Rashtchy - Piper Jaffray

Okay, that's helpful. Thanks, Jay. Second, on advertising, could you talk about what’s driving your kind of growth or, in this case, a little bit of a slight decline on a sequential basis, given that ad environment seems to be pretty strong in China?

Jay Chang

Well, I guess, for the second quarter, we booked everything basically in the second quarter for [relative] to the World Cup and Wanleba. And, as we mentioned on our previous call because World Cup obviously ended for us at least going into the third quarter, and Wanleba is actually something now that will be starting again in the autumn period. For us, it was -- we did expect to see a small or slight decline.

4Q, we expect now to be a relatively to be flat quarter-on-quarter. That’s something that’s hopefully we would like to achieve and maybe even do better on. But if you look at our 4Q guidance and what it implies in terms of ’06 versus ’05, we are still seeing roughly 45%, 50% year-on-year growth. So, we still think that’s quite healthy, obviously there is still lot of work for us to do on our portal given that we are one of the smaller players, but we will continue to focus on the entertainment side. Skype, for us is, I think, doing quite well, although the monetization will still take some time. But the trends we are seeing there we hope will flow into '07, after, obviously, the Chinese New Year period which is seasonally weak for everybody in 1Q.

Safa Rashtchy - Piper Jaffray

And one last question, if I may. There has been speculations whether there would be some sort of cooperation with eBay on their auction site. I'm not asking for you to comment on that. But I'm wondering if you could talk about you - you talk about your desire to expand beyond wireless into other ecommerce areas and, if you were to do so, whether organically or through partnerships or acquisitions. How would you kind of build the infrastructure for that kind of an expansion?

Jay Chang

Obviously, we don’t comment on rumors. But we obviously have an existing relationship with eBay through Skype. And we're very happy with that. And I think we're very happy with that, especially with how the growth is going right now, at least in the user base.

I guess, in terms of commerce, I think we are, we still want to be and we're still focused on being the leading wireless Internet company in China. We do believe that phone, especially with our relationship with UMPay, is a very compelling and again hopefully convenient way in the future for people to pay for things. So, I think leveraging on our expertise in wireless is where kind of the core area of what we are looking to expand in many different areas. And commerce is potentially one. Another one that Lei Lei mentioned is mobile advertising. So, I think that you can look for things for us from all kinds of areas, but the focus is still on the wireless Internet.

Safa Rashtchy - Piper Jaffray

Okay. Thanks guys. Great quarter.

Operator

Thank you sir. Our next question will be coming from William Bean from Deutsche Bank. Please go ahead.

William Bean - Deutsche Bank

Hi guys. Just a couple of questions. One, can you just give us a sense of the percent of revenue for China Mobile in Q3. I know you gave us the China Unicom, but for Q3 and also Q4?

Jay Chang

So, it's basically the difference. So in Q3, Unicom was just over 20%, probably in the 20% to 23% range. And then China Mobile made up the remainder of that.

William Bean - Deutsche Bank

And no [Telecom], Netcom at this point.

Jay Chang

Very minimal. Not much meaningful right now.

William Bean - Deutsche Bank

And Q4 expectations?

Jay Chang

Q4, we haven't provided that type of guidance. But I would -- you could expect that the ratio would be fairly similar to what it was in 3Q.

William Bean - Deutsche Bank

There was no real change because of Dream finishing up?

Jay Chang

We don't see much of a big change.

William Bean - Deutsche Bank

Okay. And then in terms of China UnionPay, could you give us a couple of examples of some of the things you've done in the last quarter as far as that relationship?

Jay Chang

UnionPay? UMPay?

William Bean - Deutsche Bank

UMPay, yeah, -- or UnionPay.

Wang Lei Lei

So UMPay, we just helped UMPay to extend their sales networks because we just converged some of the [worldwide] lines websites to the UMPay clients, because UMPay is very inclusive -- have the inclusive rights for the micropayment, which is kind of user can directly pay some Internet service fees through their handset service fees. So, we have just started to help UMPay to expand their sales channels.

Jay Chang

But I think probably one key thing is that the monetization of our relationship is probably going to take a little longer than we had thought previously. But I think they're still in an excellent position as basically this de facto only authorized gateway on China Mobile to develop this business. So, we're still very excited about it. I think it's just going to take a little bit more time than we had thought. So --

William Bean - Deutsche Bank

Okay. And could you just give us a sense of maybe what gives you confidence in the stability in terms of the policies and, perhaps, when you might see some loosening of the policies?

Jay Chang

Well, as I'd mentioned before, we're seeing in our books, our Unicom and our China Mobile business month to month things being fairly stable. And that does take into account that, most provinces have implemented double confirmation. So, from where we stand, whilst I think those policies in place maybe double confirmation and some cross-selling suspension still make it difficult to grow, we do think we're at a level that is fairly stable right now in terms of our overall business.

William Bean - Deutsche Bank

Great.

Jay Chang

In terms of potential loosening, I don't think that's something we expect in the near term right now. But I think, in Lei Lei's conversation with the regulators probably over the past few months, one of the things that they do recognize is that to do another kind of policy shift like this again is something that they would have to think very, very carefully because they don't want to create this much disruption as we all saw over the past quarter or so.

William Bean - Deutsche Bank

Okay. Thank you, guys.

Operator

Thank you, sir. Next question will be coming from Catherine Leung from Citigroup, Hong Kong. Please go ahead.

Catherine Leung - Citigroup

Hello. Hi. Good evening. I have two questions. One is on the margins and the other is on SMS. Firstly, on the margins; they were down significantly in Q3 and you've guided for them to be pretty much flat in Q4. I know that you indicated at the Q2 briefing that you're pretty reluctant about staff or costs because you think this is a temporary disruption and to maintain a long-term growth of your business you want to keep the staff and the talent that you have. Do you still hold that view, and when do you expect margins to trend back up? Will it just naturally rise as revenues recover or do you think you'll take more steps to proactively cut down on some of the more variable costs? And, I have a follow up after.

Jay Chang

So Catherine, it's not the variable costs which cause to decline. Those -- obviously if our revenues decline, our transmission costs decline and so on and so forth. It's really our main staff, our depreciation, our bandwidth. Some of it is portal-based, some -- for example, large SMS servers share some of the same data center space as our portal servers. And -- but I think overall, we're always looking to optimize our cost structure; but given, I think, one other things that obviously happened recently is us getting two positions on the China WAP portal -- or the China Mobile WAP portal, I think there is still lot of resources we need to have kind of at bay to take advantage of all these things that mobile operators would like us to do on their behalf. So, I think whilst we are conscious of our margin, we all -- we want to be best positioned to maintain our leadership in this marketplace right now.

Catherine Leung - Citigroup

Okay. And secondly on Infomax, could you please update us on the pipeline in terms of what programs you think are expected to have a significant revenue boost in the future for example, 6 plus 1 is that coming up, or any other programs?

Jay Chang

We don't see anything to be as potentially as big, obviously, as Dream China. But I guess other programs that we are looking at, there is a model program, there is employer of the year awards, there is business of the year, there is cooking contests. There is a lot different entertainer programs that they have that we are trying to work and develop with CCTV-2 to develop more entertainment, more interactive services. So -- and that's something I thing we'll continue throughout the 2007 period, not just something we'll just do, obviously, in short-term.

Catherine Leung - Citigroup

Okay. Thank you.

Operator

Thank you, ma'am. Our next question will be coming from Richard Ji from Morgan Stanley. Please go ahead.

Richard Ji - Morgan Stanley

Hi, Lei Lei and Jay.

Wang Lei Lei

Hi.

Jay Chang

Hi.

Richard Ji - Morgan Stanley

A couple of questions. Number one is that, it is a quite encouraging to see your wireless business stabilizing October. And, can you give us a little more color on which of your wireless line may recover faster?

Wang Lei Lei

I think for SMS, because we have seasonal revenue income from Dream China Infomax, so the Q4 SMS continue to decline [towards] the Q3 seasonal revenue and also we see the WAP had successful translation from the subscription-based to the transaction-based. And, WAP will go flat in Q4. And for MMS is flat because all subscription-based is converted to the transaction-based. And also, the IVR business because we have restarted some local provincial based co-promotion and cross selling. So, we have -- IVR business, there will be a little bit growth. And, the other reason for IVR is the Unicom's IVR business, we restarted to put the Unicom's IVR business to our TV sales channel. So, I think because of SMS the other business lines go stabilized or a little bit of growth.

Richard Ji - Morgan Stanley

Okay. Very good. Sure. The second [price] for your company this quarter is again Skype. And based on my calculation, TOM-Skype units have been adding more users per month versus the market leader. And can you help us to understand little better about what is your plan there going forward?

Wang Lei Lei

Yes, since it surpass our critical mass for the TOM-Skype because for Q3 we acquired nearly 5 million. But from October the registered user for the daily registered user base is over 100,000. So we believe that the growth is faster than before. And we will continue to do a lot of promotion to increase our TOM-Skype registered user compared with [Tenson] and the other major competitors in Mainland China. TOM-Skype is still a small player in this area. So our full strategy is to the user acquisition in the first half of 2007. And we believe we will try to monetize the Skype traffic and user base to advertising in the second half of '07. It's very difficult to say how can we make cooperation with the carrier to launch the Skype [out piece] through phone consumer base value-added service because the policy is not very clear for this kind of -- that we add.

Richard Ji - Morgan Stanley

Sure. Yeah. And my last question is regarding potential M&A. And obviously, we understand, as you have just pointed out, and the consolidated -- industry consolidation will unfold very soon and probably sooner than we expected. And what will be the area that you will be interested in?

Wang Lei Lei

Wireless focus is TOM Online's strategy. On the wireless platform, we're looking for some future applications, like mobile payments and mobile advertising. And we maintain our M&A strategy; [one] is doing half of our portal traffic, branding to the base. Second is to acquire some wireless-based companies which just have killer ads from product side and the other hand some wireless companies, like Infomax, which just have the strong sales channel for us.

Richard Ji - Morgan Stanley

Okay. Thank you very much.

Operator

Thank you, sir. Our next question will be coming from Ming Zhao from Susquehanna Financial Group. Please go ahead.

Ming Zhao - Susquehanna Financial Group

Thanks. Good evening Lei Lei and Jay.

Wang Lei Lei

Hi, good evening.

Jay Chang

Good evening.

Ming Zhao - Susquehanna Financial Group

Hi. I have one -- just one question. Seems like you have used the transaction-based product when you feel that growing the subscription-based product is difficult, my question is what's your strategy going forward in terms of the mix of these two strategies? Are you able to keep the transaction-based revenue and meantime growing your subscription-based model?

Wang Lei Lei

Do you mean from the transaction to subscription or subscription to transaction?

Ming Zhao - Susquehanna Financial Group

I mean, it seems like in last quarter you said your WAP was growing because you have implemented a lot of transaction-based products to offset the decline in the subscription-based business. It seems like that’s not a difficult thing. My question is can you keep the transaction-based revenue and then grow your subscription-based revenue again?

Wang Lei Lei

No, we believe the regulation is a strong impact for the subscription model products for the Wireless Internet. So, all direct channel strategy is focused on develop the transaction-based service. We are not going to focus more on subscription-based.

Ming Zhao - Susquehanna Financial Group

So, still subscription-based business is not your near-term focus, right?

Jay Chang

I think, the way to better categorize it is in this environment, given that double confirmation is out there, and also even for non-SMS services, there is still long-term free trial periods, its like going after subscriptions today is the ROI is actually much lower, relative to transaction, it is obviously much cleaner, relative to the policy range, and given our diverse distribution channel, something that we are able to do better than many of our competitors. I think the one thing that we found was quite interesting is that when we did transaction service, it did much better than we had thought in terms of the volume level, but also the return of users. In terms of once they download something once, they actually, many of them -- the return ratio, conversion ratio of them coming back actually was much higher than we had thought in the past, and that’s that was something that’s quite encouraging. So, we are not giving up subscriptions. It's just that subscriptions in this environment, the ROIC is much lower than it has been historically. We are still working on different ways to make subscription a long-term model; you have to give us some time. Obviously, the policies were just implemented in the last few months. But the transaction side was something that surprised us on the upside a bit. Although, I think overall, we ourselves don't like to see our business at this level when it's been in the past at much higher level.

Wang Lei Lei

And on the other hand, we will develop some own free subscription-based authorities. For example, we just want to develop some free MMS magazine tool over our subscribers, and then to leverage the free subscription user base to promote our transaction-based service. So, this is our new strategy, to leverage subscription-based free service to promote a transaction-based service.

Ming Zhao - Susquehanna Financial Group

Okay, thank you very much.

Operator

Thank you sir. Our next question will be coming from Li Tang from Pacific Crest Securities. Please go ahead.

Li Tang - Pacific Crest Securities

Thank you. First question is on your future opportunity on 3G. What kind of impact will 3G bring to you? Is there going to be a lot of new services, or such as full music download, full song downloads? Can you talk about how much a catalyst that will be to you?

Wang Lei Lei

We believe the [T-Lapse] for those 3G platform in Japan and Korea are still coming from the music and game related services. So the content are either similar, and as I mentioned before, 2.5G upgrade to 3G is not having many user behavioral change. It is similar, and for the full songs downloads in Japan, even that they just use a wireless broadband platform, but the carrier also is going only provide some two minutes MP3 download. Not the full MP3 downloads. So, I think China is similar with Japan and Korea, and it's more music or game related services to come out in the new 3G platform.

Li Tang - Pacific Crest Securities

Okay, thanks. The second question is on your Online Advertisement gross margin. Historically, it has been between 50% and 70% and I think you mentioned this quarter it was roughly 50%. Can you talk about what caused the decline?

Jay Chang

It was roughly in the mid 50% range, actually. There's two key reasons. One is, we had some additional expenses related to Rich Media platform fees, relative to iCast type of products, and given our revenue base is much slower, that's something that's going to take some time to ramp up in terms of sales. But in addition, it's also part of how we allocate common costs. If you look at our filings, we actually allocate our cost to shipment, the common costs as part of our costs services, based partly upon the revenue mix, and obviously as our revenues in wireless declined, we allocated more of the common costs to the advertising side. So that itself was the big reason for it.

Li Tang - Pacific Crest Securities

Okay, one last question. Just, what are you seeing at the long-term sustainable growth rate for the wireless Internet space in China? Do you think that once we pass this regulation change stage, you can resume the growth you observed in the last few years?

Jay Chang

That's something that's very difficult for us to say right now. I think there is still -- I think that one thing we can say is, we believe our business has stabilized relative to the existing policy environment. We think that if there are new policies, I would not totally say that's not a risk any more. But we do think that the policymakers do realize that any drastic changes from here are very disruptive, and that's something they probably want to minimize. So I think we do -- we're at a much more stable point, for us to return to growth, and what that growth is, that's still very difficult for us to say.

Li Tang - Pacific Crest Securities

Okay, thank you.

Operator

Thank you sir. The next question will be coming from Tian Hou from Unterberg Towbin. Please go ahead.

Tian Hou - Unterberg Towbin

Hello, Lei and Jay, its Tian here. I have a couple of questions. One is regarding your cross-selling suspension. Is that suspension ends, or is still going on?

Jay Chang

Do you mean the IVR cross-selling strategy?

Tian Hou - Unterberg Towbin

Yes, correct.

Jay Chang

No, you see that IVR decline and most of the reason is why is our SMS declining. So our SMS promotion platform is very important to promote IVR business. The second reason is in Q3, during the regulation period, many of the provincial-based carriers stopped the co-promotion. And IVR business is mostly coming from the local provincial-based carrier promotions.

Tian Hou - Unterberg Towbin

So from Q4, is this program -- can you resume your cross-selling program?

Wang Lei Lei

It seems many of the province -- provincial-based carrier would reopen their cross-selling platform and let us to provide more IVR based music products to their cross-selling platform.

Tian Hou - Unterberg Towbin

Okay. And other questions related to what you said at the beginning of the call, you were selected by China Mobile to provide music and auto services, so can you give a color -- some color on that, how many content channels, how many company were selected; and which channel you selected?

Jay Chang

The major China Mobile's WAP portal traffic is coming from the nine key channels from music, from entertainment, ladies' channel, auto channel, and the other nine channels, and it seems China Mobile will announce some -- they want to keep the channel outsourcing -- fully outsourcing to the key players in this WAP area, and it is about six companies have own the nine channels operation rights and they include the TOM Online, SINA, Hurray!, KongZhong, and the other key players. So, this shows China Mobile strategy. They want to have the key close relationship with key players with -- in the wireless Internet area. Some more details, there are two of the channels. The music as well as games have three different companies providing services on those channels, almost exclusively, through China Mobile's WAP portal now. And then the ladies, the cars, and the education are only one company each, and we have the car channel -- auto channel, and we're the only one. So, we completely outsource China Mobile with auto channel.

Tian Hou - Unterberg Towbin

Okay. So how does it help you to generate revenue?

Jay Chang

This new policy we will execute from the December 1, and we believe to leverage this traffic, we can get more revenues to our WAP services, and but it's very difficult to calculate how much money we can get from these channels, but I think in Q1 we have -- we can clear numbers.

Tian Hou - Unterberg Towbin

So, you are saying the revenue-sharing schedule from this primary content, these nine channels is 85 and 15, right?

Jay Chang

Yes, the same.

Tian Hou - Unterberg Towbin

Okay.

Jay Chang

Same as revenue sharing policy as before.

Tian Hou - Unterberg Towbin

Okay, got it. Okay, that’s my question.

Jay Chang

Okay.

Operator

Thank you ma'am. Our next question will be coming from Wallace Cheung from Credit Suisse. Please go ahead.

Wallace Cheung - Credit Suisse

Hi Lei Lei and Jay, good quarter. Mainly two question. First of all, again on the impact of double confirmation, we learned that full implementation on SMS service since early October, and also on MMS services, already in seven provinces already implement and maybe we will have a full implementation going forward. So, also we have the lift of the one-month free trial on SMS, so on and so forth. Can you give us maybe a summarized kind of view on how the changes have an impact on the SMS, WAP and MMS service? That's my first question, afterwards I had a second question. Thank you.

Jay Chang

So, I think for each business line there's different impacts for different policies, and I think on the back end of it, there's mainly double confirmation, which is the one that's limiting growth, and user acquisition on going forward. So for SMS, it's the cancellation of the per message subscriptions which had the biggest impact versus double confirmation itself, as well as the one-time reminder on many of the monthly SMS subscription. So not so much, although it does help, but not so much on the lifting of the one-month free trial period, and so forth.

On MMS, similar thing to SMS, for per message subscription. For WAP, obviously we actually took action, and we switched more to usage-based services, so that actually offset some of the other impacts that we saw. Although obviously to grow WAP subscriptions now is still difficult, relative to a double confirmation. And then on the IVR, is really limited not by any specific policy, but just the cross-selling kind of limitations we have in the marketplace today.

Caller ringback tone is more driven by China Mobile as well as the market forces wanting to try to get users to change their songs more often. People sign up, and then they don't change their songs, so there's been a lot of pricing pressure, in terms of lowering the per song for caller ringback tone which is -- that's in addition to all the different policies that have been limiting on promotions, which has impacted our caller ringback tone business.

Wallace Cheung - Credit Suisse

Okay, thank you. I think basically your strategy is to migrate users from subscription-based into transaction-based, actually can help to offset the double confirmation policy. Am I correct?

Jay Chang

Yes, mainly for the WAP, and obviously that's one of the things we've found that has stabilized our business.

Wallace Cheung - Credit Suisse

All right, thank you. Actually the second question is, on an analysts call, UMPay, you mentioned couple of times during the call, can you give us that data points and what kind of strategy is that actually you are executing, and how is the progress? Thank you.

Jay Chang

Well, I think as I mentioned before, I think UMPay is going a little bit slower in terms of being able to monetize. But UMPay itself, they're in a great position. So there's not a huge, huge urgency to make sure that this is -- we monetize it right away. And obviously there's user adoption curves and so on and so forth. But I think the key area we're focused on now is probably the micropayments area, using the UMPay platform, IVR numbers, so that people can dial the number and be billed directly to their phone, and that's something where we have a team working on, with them, actively right now. But beyond that, I think it is taking a little bit slower than we had thought for obviously there are the policies that are in place, so China Mobile and everybody else has been preoccupied in terms of doing anything new. And I think the user adoption curves are something that will take some time for us. And obviously our own team here has been resource a bit constrained given that we want to focus on making sure our business is stabilized.

Wallace Cheung - Credit Suisse

Okay, so basically the WAP contribution in '07 will still be as significant?

Jay Chang

As of right now, I would -- that's the way we see it right now.

Wallace Cheung - Credit Suisse

Okay, thank you very much.

Operator

Thank you, sir. Our next question will be coming from Adam Clark from Bear Stearns. Please go ahead.

Adam Clark - Bear Stearns

Hi guys.

Wang Lei Lei

Hi, Adam.

Adam Clark - Bear Stearns

Just a quick question on the IVR. I noticed that a couple of your competitors have had pretty strong quarters from IVR, and you also mentioned that you'd had some success promoting IVR with China Unicom through your TV sales channel, I am just wondering how far you think you could get with that, or what other strategies you think you could pursue to make that IVR segment grow more in Q4?

Wang Lei Lei

For IVR our product strategy will focus on developing entertainment related IVR product like music sending and some music services, our voice platform of IVR. And so our sales strategy is the way we leverage cross selling between the SMS and MMS to promote IVR services, and also the other very important sales channel to leverage our offline sales team to work closely with the local carriers to leverage their local resources to promote IVR business.

Adam Clark - Bear Stearns

I see. But absent the cross selling, would you consider other things like direct TV advertisements, or is that still not going to be your strategy?

Wang Lei Lei

I think some of our competitors [coverpass] with same TV sales channel strategy and but we didn't know their margin, because it seems that they just give the advertising fees to the TV channel it’s a different compared with our TV sales strategy. We always have a revenue sharing strategy with the TV channels.

On the other hands, this is not a simple advertising on TV. We are working closely with their channels, the existing channel team to make more interactive services for their existing entertainment or music-related content or channels on TV platform.

Adam Clark - Bear Stearns

I see, okay. And, one other question about the transaction-based WAP, you said that's doing better. I was just wondering if you could give me a sense of maybe what percentage of that revenue is coming through the operators, such as through Monternet and what percentage is through your other channels?

Wang Lei Lei

It's about 40% coming from the China Mobile's Monternet portal and the other is coming from the handset embedding. We are working closely with like Nokia, Sony Ericson, some top ten handset manufacturers to directly embed all our WAP linkage to their handset menu. And this is outside sales channels, outside China Mobile Monternet portal; and the other is like we just did through using the cross selling to promote our WAP services to our existing SMS or MMS users.

Adam Clark - Bear Stearns

Okay, great. Thanks. That’s all I have.

Operator

Thank you, sir. Our next question will be coming from Kit Low from Goldman Sachs. Please go ahead.

Kit Low - Goldman Sachs

Hi, Lei Lei. Hi, Jay. Thanks for taking my question. Very simple question, actually most of my questions have been answered except for one, so I just want to make [into]. In terms of Infomax, for up to the first installment payment, what's your estimate base of when -- on your current earn-out run-rates that you think that the next payment would be around, in terms of the absolute amount?

Jay Chang

At the current run-rate, it would be under RMB100 million for the middle of '07, based on '06 right now.

Kit Low - Goldman Sachs

Okay, great. Thank you.

Jay Chang

Under -- hopefully, much under that, but we have still lots to see. There's lots of AR collection clause in our payout structure, so that's one other factor that's kind of difficult to estimate right now.

Kit Low - Goldman Sachs

Okay. I realize that. Okay. Thank you.

Operator

Thank you, sir. Our next question is a follow up from Mr. Michael Zhang from ThinkEquity. Please go ahead.

Michael Zhang - ThinkEquity

Hey, a very quick follow-up on the Infomax. It has two parts. The first is do you know if the Dream China program will be showing again in 3Q '07? And the second part is, when does the contract with CCTV-2 expire?

Wang Lei Lei

The next year, that we'll continue the Dream China TV contents. It's very popular in China, maybe more than Super Girl for Hunan Satellite TV. And the contract, exclusive contract for Infomax with CCTV, it's by end the of 2008.

Jay Chang

But we believe that we should be able to renew it no problem, or hence, hopefully it should be auto-renewed.

Michael Zhang - ThinkEquity

Okay. So basically in 3Q '07, we should see a spike from Infomax as well because of this show, assuming it is still a success?

Jay Chang

All things being equal. However, obviously we're going to try for other businesses to, given wherever the environment is, to --

Michael Zhang - ThinkEquity

Yeah, certainly. Okay. Well done. Thank you very much.

Operator

Thank you, sir. Our next question will be coming from Lin Chi from Lehman Brothers. Please go ahead.

Lin Chi - Lehman Brothers

Hi. Thank you for taking my questions. I just wondered if excluding Infomax, what's your current revenue breakdown for SMS in terms of subscription-based products and transaction-based products.

Jay Chang

Well, excluding Infomax, SMS actually, still the bulk of it is still subscription revenues, but they're monthly subscription revenues.

Lin Chi - Lehman Brothers

And so your target would be 100% transaction-based revenue, going forward?

Jay Chang

So the bulk of Infomax from SMS business is transaction-based. But the bulk of our SMS business, after the cancellation of per message fees, is still a lot of -- a majority of it is still monthly subscription.

Lin Chi - Lehman Brothers

Okay. Then after the double confirmation rule is being implemented on provincial level, can you help us understand how about the user churn rate, after the implementation, and also the percentage of the return user for your transaction-based products?

Wang Lei Lei

I think during the regulation impact, the churn rate is higher. It's about 70% of our subscription-based users was loose. And so this is a major reason -- a major reason for the SMS impact in Q3. And the Infomax is all transaction-based SMS service.

Lin Chi - Lehman Brothers

Okay. And for the transaction-based products like for WAP, the percentage of written users, do you have a number?

Wang Lei Lei

Not very detailed numbers, but we have very successful executions to convert the subscription-based user -- user to the transaction-based. But for our business, no matter for SMS and MMS and WAP, the subscription user life period is only three months.

Lin Chi - Lehman Brothers

Okay. Another quick question, I understand some of your competitors have started looking at wireless advertising. Is that an area that you might be interested in as well?

Wang Lei Lei

We don’t want to get much more focused on the free WAP advertising. We do alliances with some mobile advertising player, which is perhaps the official licensing from China Mobile to do their own advertising business. It is complementary to our existing fixed line portal advertising business.

Lin Chi - Lehman Brothers

Okay. Thanks a lot.

Wang Lei Lei

Okay.

Operator

Thank you ma’am. (Operator Instructions).

Jay Chang

Operator, if there are no more questions, then I think we can conclude the call. And I'd like to thank everybody for listening into our third quarter results and hope to meet everybody in Beijing, very soon.

Operator

Thank you, and that concludes today's conference. We would like to thank everyone for participating. All lines may disconnect now, and good day to you all. Thank you.

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