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Linktone Ltd. (NASDAQ:LTON)

Q2 2007 Earnings Call

August 20, 2007 8:00 pm ET

Executives

Brandi Piacente - The Piacente Group

Michael Li - Chief Executive Officer

Colin Sung - Chief Financial Officer, Director

Edward Liu - IR

Analysts

Mike Olson - Piper Jaffray

Jason P. Tsai - Montgomery & Company

Mr. [Zhang] - WR Hambrecht+Co.

Patrick Lin - Primarius Capital

Presentation

Operator

Welcome to the Linktone second quarter 2007 results conference call. (Operator Instructions) I would now like to turn the call over to Miss Brandi Piacente, Investor Relations for Linktone. Please go ahead.

Brandi Piacente

Thank you and welcome to Linktone's quarterly conference call. With us today are Mr. Michael Li, Chief Executive Officer and Mr. Colin Sung, Chief Financial Officer, and Mr. Edward Liu, Director of Investor Relations.

Earlier today, we announced our financial results for the second quarter ended June 30, 2007. Michael will begin today's call with a review of the quarterly results of operations. Colin will then review our income statement and balance sheet for the second quarter, and provide our business outlook. After that, we'll open the call up for your questions.

Before we begin, I would like to remind you that during the call, we will make forward-looking statements, which are subject to risks and uncertainties. We do not undertake any obligation to update this forward-looking information, except as required by applicable laws.

Now I would like to introduce Michael Li, Linktone's Chief Executive Officer, for a summary of Linktone's business and operational results for the second quarter of 2007.

Michael Li

Thank you, Brandi, and thanks to everyone on the call for joining us today. Like most wireless providers in China, we continue to face a challenging environment for our wireless value-added services business during the second quarter. However, longer term, we believe these regulations will only help improve the industry and increase the users’ overall experience as demand for mobile data and audio services further develops.

Driven by certain programs, our strategic partner, Shanghai Dong Fang Long New Media, a subsidiary of SMG, our forecast for the third quarter reflects our expectations for moderate improvement in our wireless business. We remain confident in the development and potential of our wireless services in China as fundamentals remain strong; and we forecasted that our wireless business can grow from the levels reported in this most recent quarter.

As we have discussed in the past several quarterly conference calls, we have changed our business quite dramatically in order to diversify into advertising services to include traditional media channels for large audiences and participation-based revenue. Our advertising strategy is unique from our peers because we are not only selling our wireless portal advertising space, we are bundling these wireless and Internet and other new media channels with our traditional media to sell a packaged consumer reach to the advertisers, such as promotional events with certain venues. In this way, we are leveraging traditional media power to build our new media advertising revenue.

Our second quarter advertising services revenue more than doubled over the first quarter. We reported advertising services revenue growth from 600,000 for the first quarter to 1.6 million for the second quarter, and zero a year ago prior to our entry into the advertising market. Television advertising revenue increased sequentially from 0.5 million to 0.7 million while our product promotions sponsorship revenues increased sequentially from 0.1 million to 0.9 million. TV direct sales, consumer goods, food and beverage, automobile, electronic goods and other industries account for 33%, 31%, 23%, 9%, 4% of the total advertising revenue in the second quarter 2007.

For the second quarter of 2007, our reach to consumers through several television outlets such as QTV was approximately 200 million viewers in 23 major cities and 20 advertisers. We continued to target 300 million viewers and 80 advertisers by brand in total by December 31, 2007.

Now let me summarize the results of our wireless, non-media advertising product areas. SMS revenues were 4.3 million compared with 7.1 million in the previous quarter and 37% of the total gross revenues. Revenue from our 2.5G product, MMS, wireless application protocol or WAP, and Java totaled 1.4 million compared to 2 million in the previous quarter. MMS and WAP revenues rose quarter over quarter. The sequential decrease in Java was due to the impact of seasonality and therefore relatively fewer promotions and marketing initiatives carried out during the three-month period. Other related revenues, IVR and the CRBT were 4.2 million compared to 4.3 million in the first quarter.

Linktone has a strong balance sheet including cash and cash equivalents and short-term investments of 47.4 million at June 30, 2007. In terms of our business development achievements during the second quarter, in June, we announced in agreement with E-China Cash, ECC, one of China's leading companies to purchase a 49% equity stake in E-China Mobile, a wholly owned subsidiary of ECC. Under the terms of the agreement, as joint owners of E-China Mobile, we will engage in cross-selling promotional activities and then target the ads with ECC by leveraging each company's extensive customer resources. One of the main objectives of E-China Mobile is to establish a user-friendly platform to provide wireless value-added services and a regional context to each of its clients, which includes some major Chinese blue chip companies.

We also announced a joint venture with ShanghaiHomer & Landau Cartoon Cultural Communication Company, SHLCC, to provide animated cartoon wireless value-added services to an estimated 357 million teenagers in China. SHLCC focuses on the research and development of computer animation software for the production of cartoon programs and development of cartoon products. The Great Dreams Cartoons Club program is broadcast for 22 minutes everyday across 500 television stations in China. This joint venture will focus exclusively on cartoon content and channel resources to develop and operate wireless value-added services. It's a great example of our cross-media strategy as we continue to make positive strides in China's animation and advertising market.

Furthermore, in the second half of this year, we look forward to working with seven vendors for some promotional events related to the Olympics in Beijing next summer.

Finally, before I turn the call over to Colin, I would like to note that Mark Begert, Director of Linktone since September 2005 is resigning from the Board of Directors of Linktone effective today for personal reasons. Mark was a tremendous asset to Linktone and we greatly appreciate his services over the years and we wish him all the best.

With that, I would like now to turn the call over to Colin Sung for a more in-depth review of Linktone's second quarter financial results and some insights into our expectations for the third quarter of 2007.

Colin Sung

Thanks, Michael. Thank you to everyone on today's call. Before I begin, I would like to emphasize that the series of cutbacks in the business we've implemented several quarters ago continues to be an ongoing process and ones that our finance team spends a significant amount of time managing. Secondly, our wireless business continues to be the building block of our business and our greatest asset as an interactive media company. Our priority is still to maintain this business at a critical mass and continue to drive its profitability.

Now I will provide some details of our financial results for the second quarter of 2007. Linktone's second quarter gross revenue were 11.7 million compared to 14.2 million for the first quarter of 2007 and 23.3 million for the second quarter of 2006. Revenues for the second quarter related to services offered through China Mobile, China Unicom, China Netcom and China Telecom customers represents 59%, 9% and 16% of total revenue compared to 62%, 11% and 21% respectively for the first quarter of 2007.

As Michael stated, our advertising service revenue more than doubled over the first quarter driven by several new contracts in conjunction with our cooperation agreement with Qinghai Satellite Television via Chinese Youth League Internet, Film and Television Center. We are making solid progress on our revenues diversification strategy by building a scaleable platform of new and traditional media channels including interactive television initiatives and innovative advertising and promotional services.

Linktone's gross margin for the second quarter was 39% of net revenues or gross revenues minus business tax compared with 44% for the first quarter and 63% for the second quarter of 2006. The sequential decrease in gross margin was due to the negative gross margin of Linktone's advertising services business, which incurred significant costs in connection with operating the exclusive advertising agency relationship with CYL and certain sponsorship contracts. In addition, the margins for some of Linktone's sponsorship contracts was much lower than our traditional wireless business during this initial phase of deployment as we establish our brand name in the industry.

Operating loss was 32% of net revenue compared with operating loss of 30% for the first quarter of 2007 and operating margin of 12% in the second quarter of 2006. Operating expenses totaled 8 million, down from 10.1 million in the first quarter of 2007 and 11.3 million for the second quarter 2006. The sequential decrease was primarily contributable to decreased promotional spending via TV channels for the company's wireless value-added services and overall cost control measures implemented by the management.

Selling and marketing expenses were 3.9 million compared with 5.6 million for the first quarter 2007 and 6.8 million for the second quarter of 2006. The sequential decreases were due to lower costs related to promotional expenses and marketing initiatives given the traditional off-peak period.

Product development expenses were equivalent to 1.5 million for the first quarter 2007 and compared to 1.8 million for the second quarter 2006. Other general and administrative expenses were 2.6 million compared with 2.9 million for the first quarter 2007 and 2.7 million for the second quarter 2006. The sequential decrease was primarily the result of continued efforts to control expenses.

GAAP net losses were 3.2 million compared with a net loss of 3.4 million for the first quarter 2007 and net income of 3.1 million for the second quarter of 2006. GAAP net loss per fully diluted American depository shares, ADS, was 0.13, beating our guidance for the second quarter. This compared to net loss per fully diluted ADS of 0.14 for the first quarter of 2007 and compared to net income per fully diluted ADS of 0.12 for the second quarter 2006.

Non-GAAP net loss was 2.9 million compared with non-GAAP net loss of 3 million in the first quarter 2007 and net income of 3.5 million in the second quarter 2006. Non-GAAP net loss per fully diluted ADS was 0.12 compared with non-GAAP net loss of 0.13 in the first quarter of 2007 and net income of 0.13 in the second quarter 2006. You will find the reconciliation of GAAP financial measures to non-GAAP financial measures in our press release and second quarter 2007 financial statements which are now posted on Linktone’s corporate website at www.english.linktone.com.

Next I would like to review a few balance sheet-related items. We have cash and cash equivalents, as well as short-term investments held to maturity totaling 47.4 million at June 30, 2007 compared to 48.4 million at March 31, 2007. In the second quarter, net cash generated from operations was 1.7 million. The decrease in cash and cash equivalents was primarily due to Linktone’s investments in E-China Mobile, a subsidiary of ECC and partially offset by positive net cash flows generated from operations.

As of June 30, 2007 the number of weighted average ADS outstanding was 23.9 million compared to 23.9 million at March 31, 2007. Days sales outstanding was 112 days as of June 30, 2007 compared with 107 days at March 31, 2007.

Finally, our business outlook for the third quarter, we currently expect gross revenue to grow sequentially to approximately 12 million to 13 million. We anticipate GAAP net loss in the third quarter of 2007 to decrease sequentially to approximately 0.09 to 0.11 per fully diluted ADS. We expect to see growth in advertising services revenue in the second half of this year and look forward to 2008. We believe our revenue mix for non-WBS will be approximately 30% to 40% of total revenue.

We believe that the investments made in our new media and revenue diversification strategy are beginning to pay returns and that our financial losses will decrease in the coming quarters. We anticipate the growth of our existing wireless business and our new media platform will return the company to profitability in 2008.

Finally, I would also like to thank Mark Begert for his tremendous influence on the company during the past five years. On behalf of the company I would like to wish him and his family all the best with their future endeavors.

At this stage we would like to open the floor for questions.

Question-and-Answer Session

Operator

Our first question is from Mike Olson - Piper Jaffray.

Mike Olson - Piper Jaffray

One quick question on the WBS side. You talked about a rebound in Q3. Is there any reason to point to why you would expect a rebound in Q3? I'm just wondering if there are certain things that you're seeing thus far in the quarter or anything specific you can point to as to why it might rebound from Q2?

Colin Sung

Traditionally, Q2 is the low peak of the whole year and Q3 traditionally usually is a peak season amongst the other quarters. In addition we have a partnership with the media channel. We're going to have more close partnerships in the summertime and so far, the indication we have in the month of July, we believe we will have a sequential rebound compared to Q2.

Mike Olson - Piper Jaffray

One other quick question on the ad services business. What was the biggest driver for the sequential growth to 1.6 million in Q2 and what part of the ad services business do you think will see the largest growth in the next year? What will be the biggest vertical of growth there?

Colin Sung

The growth mainly contributed from the Q1 to Q2 is a few of the promotional events we have. One is with the ending of the [inaudible] partnership, which we started in Q1, which is ending early Q2. The second promotional event we had is with the [Skoda] which is a promotional event related to certain sports events we held in Shanghai provinces. The third one is the one we started last year in Q4 of 2006, a partnership we announced earlier related to the Fangdong Satellite Station related to the Channel Vision. Channel Vision was the first season in 2006. This year is the second season of this program, Channel Vision, and the season started in Q2 and we do see a return in promotional or advertising revenue related to that production. That program will be ending in Q3 of this year.

Michael Li

Adding to Colin's point, I think that our strategy on cross-media and also our partnership is starting to pay off. We started to build a solid cross-media platform including the traditional TV media and also the partnership with ECC China Cash, targeted advertising. I think this strategy will start to pay off starting from this quarter.

Colin Sung

To answer your question according to what's the growth or the driver for the future of integrated or the vertical market, in addition to the promotion events we like to see or at least we are focusing to driving our advertising revenue from the branded advertiser such as Coca-Cola, Pepsi, McDonald's, like that.

Operator

Your next question comes from Jason P. Tsai - Montgomery & Company.

Jason P. Tsai - Montgomery & Company

A quick question here on the wireless value-added service side: You guys saw a 25% decline this quarter sequentially. Is that all attributed to seasonality or was there any sort of shift in your business strategy as far as maybe de-emphasizing some of the sales and marketing dollars being spent in that area in favor of the advertising side? Can you talk a little bit more about that?

Colin Sung

First, we stated earlier, our wireless still is our building block; it is the core competency of our business. The reason for the drop, or the decline in the revenue, is that one is mainly due to the seasonality, a little bit. And also, the second is due to the tightening of the policy which limited our advertising or promotional events related to WBS. For example, in the Q2, this past quarter, we were cutting down tremendously for advertising we buy on the wireless side on the TV space, or TV inventory because due to the efficiency and also the return. Because a serious policy was announced early this year related to MRI as well as China Mobile’s policy to regulate the TV industry related to the certain unhealthy pressures by certain other SP providers. So there is a certain policy tightening; we're cutting back compared to the advertising dollar of previous quarters.

Jason P. Tsai - Montgomery & Company

Do you expect to reduce the amount of spend on the TV side, probably for the balance of this year? Would that be fair to characterize that?

Colin Sung

Well, there will be certain increases in our sales and marketing in the Q3, maybe a little bit more in Q4. But overall, we will see a comparative with previous year, the advertising dollar spending on the wireless will be decreased dramatically, yes.

Jason P. Tsai - Montgomery & Company

Your guidance for 30% to 40% of total revenue coming from advertising in 2007; do you expect that ratio to continue into 2008 or do you expect advertising to be a greater percentage?

Colin Sung

The 30% to 40% is for the 2008, as far as we think and we stated earlier, by the end of this year, our non-WBS revenue will be probably consist of maybe 10% to 15% for 2007.

Jason P. Tsai - Montgomery & Company

Okay. Sorry about that; I misheard you, then.

Colin Sung

No problem.

Operator

Your next question comes from Mr. [Zhang] - WR Hambrecht+Co.

Mr. [Zhang] - WR Hambrecht+Co.

Good morning, Michael and Colin; I just have a quick question regarding IVR revenue. You mentioned that IVR revenue increased sequentially because of the joint cooperation projects with certain parties. Can you give us some examples so we can get a better sense on the spending of these joint cooperative projects? Thank you.

Colin Sung

One particular one I think we mentioned in our press release as well as Michael mentioned in his call, is the ShanghaiHomer & Landau Cartoon in particular, that particular partnership, almost 90% of the revenue related to the project is coming from interactive voice-related services and also is the most effective. Another way we look at it to a lot of degree, Linktone on the content side, we're shifting to be a CP more than a SP, so we are able to generate both the revenue related both on the SP revenue as well as CP revenue as well.

Operator

Your next question comes from Patrick Lin - Primarius Capital.

Patrick Lin - Primarius Capital

Congratulations on the cash management this quarter. I have two questions. First just a simple one in terms of what are your current plans as far as U.S. visits in the next 60 to 90 days in terms of meeting with investors?

Colin Sung

Currently we have a couple ongoing projects related to our media projects, the intention, we would like to visit on the State side probably sometime in October, after October because we have an AGM meeting coming up as well in early October. So after the AGM meeting we may schedule a road trip to the States during the middle part of October.

Patrick Lin - Primarius Capital

The second question is, as we review the last six to nine months and reflect on the new media strategy can Michael and then Colin just talk about what was it that you guys were expecting six to eight months ago? Looking at the results here sequentially, almost 200% sequential growth for June quarter, how is that compared to what you guys were expecting six to eight months ago?

Colin Sung

We always set our goals very high but obviously we are still not that satisfied with the results so far currently and we're still thinking there's a lot of room for improvement but the media side is much harder than the wireless business in a way. Michael can add his comments after I finished. Basically we look at the goal we set up for this year. We do not believe we are 100% satisfied. We have a long way to go. But in terms of media, I think a lot of people are still confused with Linktone, when we come in with the advertising service revenue, when our peers are in the capital markets still view Linktone as a wireless. But right now we are starting purely advertising services coming from traditional media channels such as satellite stations, TV stations as well as radio and magazine.

Patrick Lin - Primarius Capital

Maybe I can rephrase the question then. Instead of comparing it to your internal goals I'm talking about what was it that you guided to Wall Street six to eight, nine months ago in terms of what business this could be and what you guys have ended up doing. It seems to me that it's actually progressing quite well.

Michael Li

I think that adding to Colin's part that in the near future I think that we are going to be adding the media advertising revenue as another critical piece of the total pie. Before we just had the revenues from consumers, wireless, we are taking the wireless as a media channel to the consumers. So we have 100% of revenues coming from consumers. In the future we are also talking about enterprise, that we'll take the advertising revenue from enterprise and we think that this strategy will take advantage of the media here in China and also taking the wireless as a promotional marketing channel to the consumers. So we think both markets will grow in the next couple of years a larger increase.

Colin Sung

Currently the company is operating at a loss. That's what we say in our statement. We would like to see the company with the strategy implemented and we set out to do in early this year to return the company to profitability in 2008.

Patrick Lin - Primarius Capital

I think the main question for the last six to nine months when you guys started talking about the new media business was we were wondering if this was actually a real business and you guys have actually started to deliver on the revenue so I just want to encourage you to just make sure you don’t get too humble in terms of modest in the Chinese way and just really celebrate your victories here.

Michael Li

Thank you Patrick.

Patrick Lin - Primarius Capital

Can I also just ask, I asked on the last conference call three months ago, you have 200 million people in China who understand how this new media business is working and yet you have 300 million people in the US who don’t know yet because I’m still hoping you guys have put it on the investor relations website. It’s a shame that what you guys are trying to communicate could very easily be shown but not taken advantage of on the website.

Colin Sung

We are in the process of revamping the website as well.

Edward Liu

Yes don’t worry about that project. That will be first on my priority for the upcoming quarter. We’ll get some video uploaded on there so you guys can take a look.

Operator

Management, there are no further questions at this time. Please proceed with your closing comments.

Michael Li

Thank you for your questions and for participating in today’s call. We look forward to updating you more on the progress again in November. Thanks again.

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