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Sun New Media, Inc. (SNMD)

F3Q07 Earnings Call

February 16, 2007 10:00 am ET

Executives

Bruno Wu - Chairman and CEO

Tom Schuler - CFO

Analysts

Jackson Spears - Capstone Investment

John Sheedy - Circle T Partners

Presentation

Operator

Good morning. My name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the Sun New Media Incorporated Third Quarter Fiscal 2007 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you.

And it's now my pleasure to turn the floor over to your host, Dr. Bruno Wu, Chairman and CEO. Sir, you may begin your conference.

Bruno Wu

Thank you operator, and thank you everyone for joining our third quarter fiscal 2007 conference call. I am here today with Tom Schuler, the Chief Financial Officer for our company. Tom will lead off the call with the required disclosures and a brief review of our financial and operational results for the quarter. Tom, please.

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Tom Schuler

Good morning everyone and thank you for joining our call. Before we start our call, we need to make you aware of certain statements in this conference that do not describe historical facts, including and without limitations, statements concerning future financial and operational performances, the impact of partnerships or alliances, future strategies and plans or market conditions that may constitute forward-looking statements.

Such statements are based on current beliefs and are subject to a number of risks and uncertainties that may cause the actual results to differ materially from those statements. Any forward-looking statement should be considered in light of the risk factors that appear in our Securities and Exchange Commission filings, including specifically, our Annual Report on Form 10-KSB as filed with the SEC on June 30, 2006. We undertake no obligation to update any forward-looking statements that we may make today.

By now, you should have seen this quarter's earnings release. If you have not, it is available on our website at www.sunnewmedia.net. The replay may also be accessed until February 23, 2007 by dialing 1-877-519-4471 or 1-973-341-3080 for international callers. The replay pass code is 8420439.

I will begin by providing a brief review of our third quarter and nine-month ended period December 31, 2006. And due to our limited operating history, we do not have comparable results from the prior year.

Revenue for the third quarter of fiscal 2007 was $4 million, with gross profits in the same period of $1.9 million and a gross profit margin of 47.5%. Operating loss for the third quarter of fiscal 2007 was $26.7 million. Operating results include general and administrative costs of $1.6 million, depreciation and amortization expense of $0.7 million, consulting and professional fee expenses of $0.3 million, a gain from the repurchase of stock grant for no consideration of $0.5 million, and a $26.6 million loss on the impairment of goodwill and intangible assets. The non-cash impairment charge was associated with the previously announced restructuring of our beverage business and the associated retirement of 14.9 million shares.

Excluding the impact of the $0.5 million gain and the $26.6 million loss on impairment of goodwill and intangible assets, on a pro-forma basis, operating losses would have been $0.6 million.

Sun New Media reported third quarter fiscal 2007 net loss of $26.9 million or $0.27 per diluted share outstanding. On a pro-forma basis, excluding the impact of the gain of $0.5 million recognized on the repurchase of stock grant at no consideration and the $26.6 million on the impairment of goodwill and intangible assets, the company would have reported a loss of $0.8 million or $0.01 per diluted share outstanding.

Revenue for the first nine months of fiscal 2007 was $18.9 million, with gross profit in the same period of $14.3 million and a gross profit margin of 75.7%. Operating loss for the first nine months of fiscal 2007 was $16.3 million. Operating results included sales and general and administrative costs of $5.1 million, depreciation and amortization expense of $2 million, consulting and professional fee expenses of $1.3 million, stock-based compensation expense of $2 million, and a gain from repurchase of stock grants at no consideration of $6.3 million, and finally, a $26.6 million loss on the impairment of goodwill and intangible assets.

Excluding the impact of the $6.3 million gain and the $2 million stock-based compensation expense and the $26.6 million on the impairment of goodwill and intangible assets, on a pro-forma basis, operating profit would have been $5.9 million.

Sun New Media recognized other income of $10.9 million in the first nine months of fiscal 2007. This includes approximately $10.7 million for the sale of certain B2C, non-core assets to Sun 3C Media, which was formerly known as Sun TV Shop Plc, which was an AIM-listed company operating in the B2C space.

Among the assets sold to Sun TV Shop by Sun New Media, were an interest in Digital Mail Order Catalogs business partnership and online digital publishing rights to various offline B2C publications.

The company also had a non-cash expense of $2.6 million associated with the amortization of the discount of a note issuance.

Sun New Media reported net loss for the nine months ended December 31, 2006 of $8.6 million or $0.06 per diluted share outstanding. Excluding the $10.7 million gain on asset sale, the impact of the $6.3 million gain recognized on the repurchase of stock grant at no consideration, and the $2 million stock-based compensation expense, $26.6 million loss on the impairment of goodwill and intangible assets, and a non-cash expense of $2.6 million associated with the amortization on the discount of a note issuance, on a pro-forma basis, the company would have reported earnings of $5.4 million and earnings per diluted share of $0.05 per share.

During the quarter, the company completed several significant transactions, including restructuring the beverage distribution business and reducing outstanding share count by 14.9 million through that transaction, completing the acquisition of our electronic components marketing and distribution business in October. We restructured the corporate overhead costs and expect to see significantly lower expenses in corporate overhead in the future. And subsequent to the end of the quarter, we restructured our warrant financing agreement with Barron Partners, thereby reducing the total number of outstanding warrants from 11.5 million to 3 million.

At this time, I would like to turn the call back over to Dr. Wu.

Bruno Wu

Thank you, Tom. The last nine months have represented the inception of execution of the company's vision of building China's leading Internet-based marketing and merchandising company, with the focus of targeting China's retail and commercial clients.

Even though we have been following the right directions, we've made a significant effort in integrating company's knowledge and experience into a newly acquired business. And like all acquisitions, integrating several acquired companies requires extensive fine-tuning and we have done so by enlisting the best of resources to ensure that this is a seamless transition.

In addition, we believe that a viable company must be supported by a solid operating structure with a strong management team that puts interest of the shareholders first, and hence, we have focused our efforts on the long-term benefits of the company by committing additional resources to building a solid corporate infrastructure.

Following an aggressive period of growth and the expansion, we are pleased to announce that we are now nearing the completion of our corporate reorganization process. We remain optimistic about our business and market potential and anticipate a strong year of growth ahead.

Although we'll continue efforts in expanding our existing online distribution apparel business, our ultimate vision is to build NextMart, which we want to build into China's largest online direct to buyers community, which would consist an array of consumer products supported by state-of-art B2B and B2C marketing and merchandising platforms.

Our online portal of virtual shops will have more visibility and a harnessing cutting-edge technology. NextMart will be an online shopping metropolis along with our consumer ratings, comments, and feedback. This will allow business and consumers to purchase products and services online with ease and security, and enjoy direct order delivery with the simple click of a mouse button.

To execute this vision, we are prepared to launch on two new products, basing upon the fast-growing apparel vertical that we have, and aim at enhancing online shopping in China, particularly with apparel and fashion business, using our interactive media and [Meon-to-go] payment systems.

These products are, respectively, NextMart exhibition, which we were targeting at open, branded online boutiques and the NextMart E-Guide, which we hope to leverage our community of consumers and to reach out to close to 50 million consumers on a monthly basis by middle of 2007. So, our NextMart E-Guide will be the first interactive shopping guide in the world with an integrated payment system, and our NextPay transaction system will be China's first commercial system to facilitate bank payment via phone and Internet.

We are continuing with our merchandising business and our brand agency strategy. We have been working with a zero inventory business model since October of last year. Going forward, we plan to enhance this model by developing our own brands and acquire interest in selected products that we distribute. Our recent partnership with Himalayan Water exemplifies our strategy to play a leading role in China's fast growing high-end mineral water's market.

In addition to the exciting operational developments, we have also taken measures to retain and maximize shareholder value and remain focused on our primary business objectives.

To date, we have bought back and cancelled with this a warrant cancellation of 8.5 million shares, 23.4 million shares in total and reduced outstanding number of warrants. We have also undertaken a restructuring process through which we have decreased our total cost by over 60% from October to up to date, streamlined an operation and reporting structure and increased profit margins. Since early October, the company has also taken significant steps to successfully reduce operating costs and increase cash flow.

Going forward, we will take the following steps to enhance company share value. We will further reduce the number of issues and outstanding shares thereby reduce dilution. And we will divest of certain non-core assets so the management can remain focused on its primary business objective.

We remain highly focused on our core strengths in marketing to our business niche, and are committed to devoting our best efforts to achieving our goals. We express our deepest gratitude to our shareholders for a longstanding support and look forward to progressing with our vision and with their support in 2007.

At this time, I would like to open up the call for questions.

Question-and-Answer Session

Thank you. (Operator Instructions). Your first question is coming from Jackson Spears with Capstone Investment. Please go ahead.

Jackson Spears - Capstone Investment

Bruno, how are you today, sir?

Bruno Wu

Jack, how are you?

Jackson Spears - Capstone Investment

Could you walk us through the rationale of the Andrew Worden transaction? And related to that, do you have any plans to raise additional capital to fund your business?

Bruno Wu

Okay. Thank you very much for the question. First of all, I think the Andrew Worden deal was a sensible decision for the company going forward. Not only that reduced dilution, but also when we entered 2005 where we signed up that Worden deal there was a clause in there, that no matter what fund raising that we do in the past that there will be a share price adjustment. That means that the exercise price could go significantly lower in the event of any price adjustments. Therefore, we believe it's very sensible to get rid of the majority of it. So, we have a freehand of not only reducing dilution or going forward with whatever we want. What was your second question, Jack?

Jackson Spears - Capstone Investment

Related to that, what are your capital needs? And by doing the Andrew Worden transaction, does that free you up to raise some external capital?

Bruno Wu

Correct. The company since its inception through the Worden deal, we have only raised $8 plus million. But because of the fact that in early stages of the company in quarter one and quarter two when our beverage deal did not hit all of these difficulties and the change of the policy and financial difficulties of our main client, the company actually committed somewhere around $6.4 million in the first quarter, either spent or committed in acquisitions. For example, acquisition of CAC and [K-Pax], and technology development investment and so on and so forth.

So therefore, with that in quarter one and quarter two, we successfully actually acquired lot of valuable assets, which because of difficulties that we started to have in Q3 in restructuring and limited resources that came with the restructuring of a beverage vertical, we have not got a chance to monetize these assets.

Now, amongst assets we have right now, I would like to point out that we have one of the best database of the business in China with 17 million businesses updated and now put on to an Oracle-based platform. And we have made an investment in electronic component, which now turns out to be producing a nice profit. So, fee of acquisition now turns out to be extremely low at this stage. We also got the best virtual reality technology, the best e-publishing technology. We are on the cutting-edge of all these technologies, but they have not been monetized.

So, in other words, we raised 1 million in quarter one just on CapEx and so on and so forth. Investments and acquisitions, we already spent 6. So, up to this point, even though we have significantly reduced the company's cost, when I took over as CEO, we were going at a running rate of $8 million a year, of which 60% was non-operation related. Now we are down to between $1.9 million and $2 million a year, all inclusive.

So, with the $8 million raised and without a company collect it, we still have $1 million plus cash on hand. So, now the corporate cost is being significantly cut down, going forward, but we still have some outstanding professional fees that are being accumulated at past couple of quarters, that finally we would repay, yes. So, to answer your question, there is a possibility that we will raise some funds down the road to build up the cash quotient on the company.

Jackson Spears - Capstone Investment

And efforts in restructuring and changes, has there been any changes in the operating management or do you have any plans to make some changes in the operating management to strike and fill in some of voids?

Bruno Wu

We've obviously being doing that. We have put in a very good President for China operations. George Huang has joined us. Who of you follow the press release, he was the Head of the Sales and Marketing for Hewlett-Packard and for major US corporations, but we have two very strong additions. One already came onboard and one is going to come onboard soon, that we hope to announce that to the public soon, but that's from the top operating management level.

And with me spending lot of time with fixing it, I am bringing also team from all over the Sun Media family group, for example, to enhance sales and marketing aspect of the company, I brought on General Manager of Sales and Marketing at China Business Post onboard. But I think the two additions that we will be able to announce will show the kind of level of a commitment that we have in enhancing the management capability on operational level for the company.

Jackson Spears - Capstone Investment

Okay, thank you, Bruno. I will let someone else to ask a question.

Operator

Thank you. Your next question is coming from [John Sheedy] with Circle T Partners.

John Sheedy - Circle T Partners

Hi, Bruno.

Bruno Wu

Hi, John, how are you?

John Sheedy - Circle T Partners

Good, thank you. Couple of questions about NextMart, I was hoping that you could give us just a little bit more information on the opportunity here, where you are initially going to be focused?

Bruno Wu

Okay.

John Sheedy - Circle T Partners

What the economics are? What percentage of sales you're thinking to be able capture? And what support you have from the financial community? And what banks you'll interface with?

Bruno Wu

Great, thank you very much, John. That's a very good question and that's a part we are very excited about. You see right now, we have three verticals right now. One is beverage of course, the other is apparel and fashion, the other is electronic vertical, right?

Now, the apparel vertical currently is doing a running rate of between 3 to 4 million in a profit for the current fiscal year. And so the apparel business is a very strong, solid growing business, and we need to first of all focus on getting our fashion apparels' business going forward, okay.

Now secondly, the apparel business has tremendous synergy with other parts of my group, for example, the other company that we own, HerVillage today has between 6 to 7 million per week of unique visitor. That makes it to about 28 million per month unique visitor.

Now according to the Gartner's, Gartner was an IT research firm, their Chinese partner or Chinese affiliate [Analysis], just after three months survey, they produce a result, showing that all demographics, all visitors, of all women online products, 84.2% are actually with a income of 3,500 to 8000 R&D, which means there is a upper middle class urban professional women. And that number is fastly approaching 10 million a week for us in terms of unique visitors, which makes it, according to Analysis, the largest women multimedia community in the world. So, fashion business, we would have great synergy, for example, with this women community that we already have.

Now thirdly, in the first couple of months, the company has been able to develop tremendous capability on online technology. And I look forward to see whether it's possible for us to put a demo on our website then I will certainly notify our shareholders, so you can take a look for yourself a virtual reality, a shopping mall technology. For example, it's like a game and everything looks real. So, you can open up a brand fashion store without having to pay the real estate.

Now, our virtual reality, right now our technology, we believe we are amongst the best at least in China and also with very little data file. So, you don't need to have a broadband to access it. You can access even via wireless. So, it's a very good technology. We have another technology that is state-of-the-art, which is e-publishing. In other words, we can send electronic digital magazines. We can send digital catalogs, all that online. So, these three capabilities together with our existing sales and profit already within apparel vertical has enabled us, John, to come to the next business model, which I am going to describe to you right now.

So, what we then decided to do after we have talked to several leading international apparel groups as well as the Chinese domestic apparel groups, which had lot of brands for them? We identified the following strategy. Because right now, the biggest online purchasing populations in China are actually urban, young, professional women, and they actually spend money to buy second tier particularly and third tier brands. Because they are price sensitive. They want to be fashionable. And they are very sensitive to pricing, that's why these are the people who chose to buy stuff from a known brand online. And that happens to be the exact audience that all our community media covers.

There are currently 7 million and soon to be 10 million through affiliations with another company or with Sun Media Investment, called HerVillage, which touches the content side. So, we can then go in and do the commerce side with them. Now, the way we do it is, first of all, it's on the B2C side. Now, we approached quite a few groups with many brands. And they immediately responded very, very warmly to this idea. So, our business model is very simple. We help them to build. If you have a brand ABC, we help you to build a virtual store of ABC where all your products are displayed on a virtual reality website rather than a dull looking old website.

Now, with that virtual reality website, you basically have ABC online boutique, okay. Now, the ABC online boutique then gets consolidated into nextmart.net. Now, nextmart.net will probably by end of 2007 carry about 200 brands, that's our target, 200 brands from all over the world at the boutique stores. We have four revenue sources with it. A is, every brand will have to pay us upfront cash fee to set up their store or they have to let us keep a said amount plus a premium of the initial product sales, in other words, quasi-barter. So, now the acceptance level of the brand that we talked to is over 90%. And they are very happy with that because they can afford not to have a cheap thing like that to appear to their consumers.

Then this nextmart.net, which we are going to launch in March, then the second revenue source, is going to be the ongoing transactional

Now, because for middle, second-tier products, and third-tier products, because the absolute price level is lower, so people are even more sensitive to the need of cutting the tremendous distribution cost and distribution layers in middle, and that has always been the aim of the company to cut down the distribution layers.

So, therefore, once you have our typical cutting transaction revenue is right now anywhere from 10 to 40% of the transaction figure.

Now, thirdly, our third revenue source is online advertising. Now we are in the middle of working with our leading online advertising agency in China about representing us. Because as I said, we now have the most authoritative and incredible survey results, which show that all 84.2% of our visitors of income level between 3,500 and 8,000 RMB, as our leading portal in China will show 60% plus have income below 1,600.

So, that will show that we captured some buying power here, very obviously. So, we would like to workout the deal with our leading online advertising agency, so they can keep on selling their stuff, so that revenue is now number three.

And remember, the number four is the maintenance cost, because once our brand heads are still up, they always have to pay to present the new garments, or new apparels and new fashion stuff or bags stuff out there. So, every time you have to pay us to maintain it.

That whole revenue package has been worked out and we are in the middle of talking to our three or four selected clients to make sure that that would reflect what the market would accept, and we intend to launch that in March.

So, in other words, we will have a NextMart.net. It's like virtual apparel more to begin with, with which you have a real shopping experience when you go in there. Now, that website and that mall will be promoted throughout our media.

In other words, right now, every week, there's 7 million women downloading electronic magazine, there's altogether 20 million women visiting our media properties, including our women channel on Sina.com, which we have a sub-women channel or Her Village on Sina, which is China's number one portal, including perhaps with affiliation with other online properties that we don't own, but we have a very close working relationship with.

So, we will be able to have access to a lot of target. In excess, I think, very quickly, in the area of women, we will have more than 30 million a month in the near future, a unique visitor that we can approach.

Now, that again, give us a tremendous leverage over those brands, because then they have an online display, they have a showcase, and that brings them additional revenue. Now, this particularly attracts to the multinationals, who do not want to go into China and play the dirty local distribution game. So, multi-leading apparel groups with the direct mail and direct sales group and one of their arms are particularly interested to explore those opportunities with us.

So, now the payment on logistic is very simple in China. If we have logistic companies all throughout China, now we have got [eBay] pay, you can either choose to pay other banks through our UnionPay online with the ease of mind, or you can choose to use a traditional way and then you send us the money first in a check -- just like in a mail order business, send us the money and then we ship you the goods.

So, that's on the B2C front. Now, apparel also has tremendous future on the B2B front, which is again a very strong expertise of existing operation in William Brand. Because of the fact that a big percentage of the world's garment manufacturing are done in China and today a lot of the Chinese investors investing in tremendous manufacturing and designing capabilities and they are looking for business. And wining brand is a connoisseur in that area because they've been in that business for between 15 to 20 years. And even management has been in the business of B2B. So therefore, we have also approached several leading manufacturers and they also loved the idea of setting up a virtual display house. And we have added a video capability. So, if people so choose, they can look at the showrooms of these manufacturers and designers.

Again, we are in the middle of doing that. And again, these people are willing to pay us according to -- may be not advertising revenue that much, but the other three revenues of initiation fee and also transactional percentage and also maintenance fee can be worked out. But that will be worked out rather than us having a flat rate between 10% to 40% as we're maintaining over the B2C side of the business, that's going to be a case-by-case.

So, we are going to take the next 12 to 24 months very focused on apparel business, working both on B2B and B2C sides. By the way, B2B, we also have the database of all the apparel manufacturers of China as a part of us. And not only manufacturers as well as the retailers as a part of our 17 million business database. So, we will be very focused with that. And as we do so, we will be able to enhance and reinforce the earning capability of the apparel vertical. So, that was NextMart in apparel first.

Now, the electronic part. The China Consumer Electronic Show, which we own the on-line rights as a part of the deal, on-line exhibition rights. China Consumer Electronic Show is already the second largest consumer electronic show in the world only after the Las Vegas Show. So, while we are focusing on building the apparel on the NextMart on the electronic side, even though the business is currently profitable, this quarter it has a run rate of between $200,000 to $300,000 in US in earnings.

So, we will let that part solidify itself a little bit. And we will direct more resources to fully focus on apparel with limited resources and hopefully 18 to 24 months later when are getting to more of harvest time with our apparel vertical, it will be more material for us to then launch our second electronic vertical. Whereas, our traditional business, the one we started with, the beverage business, when we start with [defending] TsingTao beer.

There are also two remarks I would like to make. First of all is, even though we have written-off that entire investment due to the cancellation of 14.9 million shares, it's prudent to do so because we are no longer selling TsingTao beer, and it's rather to do it early than later. However, we cancelled all the 14.9 million shares we issued. So, it's only accounting thing that we had to write it off. We also collected $2 million to $3 million cash. We own the management team which is a very good team. We still own that management team. And we still own the good purchase software that we bought from them as part of our focus. And we also have the distribution network in Central China in Wuhan to mom-and-pops.

So, even though that business has been completely written-off, they have been working diligently on the Himalayan project. And hopefully, there will be very soon opportunities for us to monetize on the Himalayan project starting from time Q1 of next fiscal year. But the issue is this; beverage is not a typical online distribution business when you come to B2C side of it. Even for B2B, it only limits ourselves to the smaller scale retailers. So, we will be looking for other ways of monetizing Himalayan. That's why we didn't chose a beverage to become our number one target to consolidate our efforts on? I hope that answers your question, John.

John Sheedy - Circle T Partners

Yes, very helpful, Bruno. In fact I have a couple of follow-ups if I can.

Bruno Wu

Yes, please.

John Sheedy - Circle T Partners

The launch of NextMart in March--

Bruno Wu

Yeah.

John Sheedy - Circle T Partners

How many brands are you targeting to be available there on the launch?

Bruno Wu

Don't hold me to it. My target is to contractually secure over 100 by the time I launch. But manpower wise, how quickly you can put them online is another matter.

John Sheedy - Circle T Partners

Yeah.

Bruno Wu

And I can further tell you the following, its pure management targets, so I am not guaranteeing anything. Number one is I would have liked to completely dominate the domestic women fashion apparel brands. In other words, there are two systems in China, one Shanghai-based, one Central government-based, which is Beijing-based of ranking Chinese domestic designers and brands. They rank top-ten in each case. I would have liked for both of these top-tens as part of the initial offering in my domestic approach.

John Sheedy - Circle T Partners

Thanks. Got it.

Bruno Wu

And I would also like to work with leading European, particularly French luxury and apparel groups with its direct sales group. I like to work with the leading Japanese direct sales groups and I also would like to approach the Americans. So I would like to have become a condo for the big Japanese brands, because Japanese fashion is very popular in China and in Asia as a whole. French as well much more so than American brands. So anyway, I would like to have a representative from a large group from Europe, America, and Japan, and China to set a qualitative sort of tone for what we're going to do. So in other words, this virtual reality online shopping experience is something to see John. And I will put this on the web and I will show you when I come to New York next.

John Sheedy - Circle T Partners

Great, thank you very much, Bruno.

Bruno Wu

You're welcome, John.

Operator

Thank you. (Operator Instructions). There appears to be no further questions in queue at this time.

Bruno Wu

Thank you very much. Thank you everybody for joining us and I also wish everybody a very happy Chinese New Year after you had a very happy Western New Year. And if you have any questions, do not hesitate to contact me, Tom Schuler, or Nick Topjian and we'll post our contacting on the web, and looking forward to working with you in the future.

And what I have to end up this conversation by saying is that this last quarter has been primarily a restructuring quarter for us. We are prepared to bite a bullet and just cut our cost down to bare minimum, at the same time to protect and grow the good revenue source they already have and become a lot more focused.

Prior to that, I think our corporate overhead was way too high. It ran between 5 and 6 million just for the first nine months of the company, as you could see. And if that had to continue, the company could not sustain itself. We are very happy that we got that cost down.

And we are very happy that the company is very strongly back on feet going forward with the model that I just described by capitalizing on our assets that we have and there are a lot of great assets and performing assets with the company we would like to focus on.

You have the full commitment of myself and the management going forward. And I thank you very, very much for your support during the difficult times that we had in the last quarter or so. And you've got my commitment that we'll perform as well as we could in the days ahead. Thank you very much.

Operator

Thank you. This concludes today's Sun New Media Incorporated conference call. You may now disconnect.

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