Ladies and gentlemen, thank you for standing by and welcome to the Linktone Third Quarter 2005 Earnings Conference Call.
Operator Instructions As a reminder, this conference is being recorded today, Thursday, November 17th, 2005.
I would now like to turn the conference over to our host, Ms. Brandi Piacente. Please go ahead, ma'am.
Brandi Piacente, Investor Relations
Thank you, operator, and welcome to Linktone's regular quarterly conference call. With me here are Raymond Yang, Chief Executive Officer, and Colin Sung, Chief Financial Officer. Earlier today we announced our financial results for the third quarter, ended September 30th, 2005. Raymond will begin today's call with a review of our recent business highlights. Colin will then review our income statement and balance for the third quarter and provide our business outlook for the fourth quarter and after that we'll open the call up for your questions.
Before we begin, I would like to remind you that during the course of this call we will make forward-looking statements that are subject to risks and uncertainties. These statements include, but are not limited to, statements regarding Linktone's business objectives and plans for 2005 and the anticipated impact of certain business events such as changes in mobile operators' policies, Linktone's subsequent entry into the casual online gaming market in China following its acquisition of Brilliant Concepts Investments, its acquisition of Beijing Cosmos Digital Technologies and its recent strategic investment in 9Sky International, Ltd., Linktone's 2005 gross revenues and net income and outlook for fourth quarter 2005 financial results. You can also identify forward-looking statements by terminology such as “will,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” and similar statements.
The accuracy of these statements may be impacted by a number of business risks and uncertainties that could cause our actual results to differ materially from those projected or anticipated, including risks outlined in our filings with the Securities and Exchange Commission, just as our registration statement on Form F-1 and the annual report on Form 20-F. We do not undertake any obligation to update this forward-looking information except as required under applicable law.
Now I'd like to introduce our CEO, Raymond Yang, for a summary of Linktone's business highlights for the third quarter 2005. Raymond?
Raymond Yang, Chief Executive Officer
Thank you, Brandi, and thanks to everyone on the call for joining us today.
I'm pleased to report that Linktone posted a record result for the third quarter 2005 due to the success of our diverse service offering combined with a focused multi-channel marketing distribution strategy. Those record results were the result of our continued focus on our two core strategies.
First, we continued to grow our leading position in distributing service through off-deck penetration, which means those services promoted directly through our own advertising in the marketing channels to mobile consumers. Our leadership in delivering off-deck service were accentuated by the company's partnership with Hunan Satellite Television enjoying our new record-breaking television show, “SuperGirl.”
Second, we continued to execute on a broad number of product development and marketing strategies that increased our on-deck penetration. That is, we used marketing and sales strategies executed through a mobile operator to reach our customers. On-deck growth this quarter were driven, among other factors, by our recent position in providing WAP services to China Unicom through our recent acquisition of Beijing Cosmos.
With the strong trend in growth of mobile phone users in China that we believe are still very much intact, Linktone has been able to leverage its established strength, innovative, diversified product portfolio, broad technology platform, focused marketing programs, international and local partnerships, national and local sales channels and a steadily growing user base, to expand aggressively into growth areas such as music, advanced gaming, graphics, instant messaging and community, which Linktone had categorized as Magic for China wireless service landscape. To capitalize on those trends, with a well-defined strategy in place, Linktone has now grown its revenue base to place it among the top 3 of NASDAQ-listed Chinese wireless service providers.
During the quarter, we continued to expand and maximize our partner channel relationships, including a partnership with Hunan Satellite Television and its very popular program, “SuperGirl,” which effectively increases our market penetration and the branding capability. We provide wireless service for the programs, which included voting, music downloads, ring tones, news alerts ,all through our robust and highly scalable technology platform. As a result, we were able to attract new users throughout the quarter. Due to the success of the “Super Girl” partnership, we already have plans for future cooperation with Hunan Satellite Television in its upcoming new programs.
Recently we announced our strategic investment in 9Sky, China's leading online licensed music company. We believe 9Sky is unique because it combines a well-recognized brand with a history of innovation and early movement toward providing legal, licensed music services and products. We believe that by incorporating 9Sky's brand, music platform and user base of over 1 million registered users into our existing portfolio of device service offerings, we will be able to extend our leadership in providing seamless music service and products over online and wireless channels.
Through a combination of successful sales promotion and increased penetration of new provinces with China Netcom, China Unicom and China Telecom, our SMS revenue grew 32% sequentially to reach $13.7 million, which accounts for 66% of total revenue for the third quarter 2005.
Colin will discuss in further detail Linktone's third revenue trends in his financial overview, but overall, we reported record revenue and net income for the quarter. Gross revenues reached a record $20.5 million, up 17% sequentially and 54% over the same period in 2004.
We previously mentioned SMS revenue growth 32% from previous quarter to account for 66% of total revenues. 2.5G audio-related revenue totaled $6.2 million to account for 30% of total revenues. MMS, WAP and Java games remained steady and account for 9% of total revenues in the third quarter of 2005, while audio-related service, including IVR and RBT, generated 21% of gross revenues.
U.S. GAAP net income was $4.1 million or $0.15 per fully diluted ADS, excluding $0.6 million non-cash stock-based compensation expenses. Adjusted net income for the third quarter 2005 reached $4.6 million or $0.17 per fully diluted ADS, up 7% from adjusted net income of $4.3 million in second quarter 2005 and up 28% from $3.6 million in the same period in 2004. This also brings us U.S. non-GAAP net income per fully diluted ADS for the first 9 months of 2005 to $0.46 per fully diluted ADS.
Looking into the fourth quarter this year, we plan to not only continue executing on our existing initiatives but also to increasingly focus on driving return on our investments, especially in specific area such as advanced gaming and music. Additionally, we see WAP as a growing catalyst for our top line going forward.
We have made aggressive inroads in marketing and product development to further enhance and position our diversified wireless products and services and expect to maintain strong long-term growth in the positioning in the market place to maximize shareholders' return.
Now I will turn the call over to Colin for a review of third quarter's financial results and our fourth quarter business outlook. Colin?
Colin Sung, Chief Financial Officer
Thanks, Raymond. Linktone's third quarter gross revenue were $20.5 million compared with $17.5 million for the second quarter. The increase was due to robust SMS revenue combined with steady diversification across a wide variety of product areas, including MMS, WAP, IVR and RBT, as well as contributions from newly acquired subsidiaries.
Average monthly paying users grew to approximately 8.3 million, particularly due to a diversification of our product offering and effective cross-selling of higher-value products to our SMS user base. Average monthly revenue per user for the third quarter 2005 was approximately $0.71, unchanged from the previous quarter.
Third quarter sales of 2.5G and audio-related services were $6.2 million or 30% of gross revenue compared with $6.9 million or 40% for the second quarter. Third quarter sales of audio-related services declined sequentially and accounted for 21% of gross revenue, slightly down from 27% for the second quarter. IVR sales increased by 14.5 sequentially and contributed 11% of non-SMS revenue while ring-back sales decreased by 6.8% sequentially and generated 11% of non-SMS revenues.
Third quarter sales of SMS were $13.7 million or 66% of gross revenue compared with $10.4 million or 59% for the second quarter. the sequential increase demonstrated Linktone's successful execution of sales promotion and increased penetration of new provinces with China Netcom, China Unicom and China Telecom.
Newly acquired subsidiaries, Brilliant Concept Investments, Ltd., an online casual game company and Beijing Cosmos Digital Technology, a China Unicom WAP service provider, combined a total of 6% of total gross revenue for the third quarter of 2005.
Third quarter gross margin was 61% of net revenue, which is gross revenue minus business tax. This was down from 66% in the second quarter and 68% from the third quarter for 2004. This decrease is within Linktone's historical gross margin range and was primarily due to the revenue-sharing arrangement with certain content and production partners.
Third quarter operating expenses were $8.3 million or 42% of net revenues compared with $7.8 million or 47% for the prior quarter. The sequential increase reflected higher personnel expenses resulting from headcount addition in the product development department, investment in printing and broadcast media and expenses related to increased research and development in order for the company to maintain its leading position and to continue delivering long-term growth to our shareholders.
Product development expenses were $1.6 million, up slightly from $1.5 million for the second quarter, reflecting increased focus on developing our casual online game business, our in-house developed instant message aggregator and the company's Java games.
Sales and marketing expenses were $3.9 million, up sequentially from $3.4 million due to an overall increase in our marketing expenses with a specific focus on printing and broadcast media.
Although we increased product development, sales and marketing expenses in the third quarter, we continue to see these investments showing direct results to our top-line growth.
Non-cash stock-based compensation expenses was $0.6 million, up slightly from the prior quarter.
Our general and administrative expenses were $2.1 million, a decrease from $2.4 million in the second quarter.
Our primary focus is to continue to maintain a tight control on expenses while investing in core areas of focus for the company.
Our third quarter net income under U.S. Generally Accepted Accounting Principles, GAAP, was $4.1 million, up 11% from $3.7 million for the second quarter.
Linktone's net margin was 21% in the third quarter compared to 22% in the prior quarter. Operating margin was 19% of net revenue compared to 19% for the prior quarter.
GAAP per fully diluted ADS were $0.15, an increase from $0.14 in the second quarter. Excluding the effect of non-cash stock-based compensation expenses of $0.6 million, adjusted net income for the third quarter was $4.6 million or $0.17 per fully diluted ADS. This compares sequentially with adjusted net income of $4.3 million or $0.15 per fully diluted ADS, excluding one-time non-cash expenses for the second quarter.
You will find a reconciliation of GAAP financial measures to non-GAAP financial measures in our news release and financial statements on third quarter results, which are posted on Linktone's corporate website at www.english.linktone.com.
The number of weighted average ADS outstanding for the third quarter was 27.7 million compared with 27.5 million for the second quarter.
On the balance sheet at September 30th, 2005, we had cash and cash equivalents, as well as short-term investments held to maturity total $75 million. In the third quarter, we generated positive cash flow from operations of $0.7 million, lower than $2 million for the second quarter of 2005 due to a slowdown in the collection of accounts receivable from certain provincial operators.
At September 30th, days sales outstanding, DSOs, was 94 days compared with 87 days at June 30th, 2005, due to some delays in account settlement with certain provincial operators.
Having received shareholders' approval in September for a stock repurchase program for the buy-back of up to $15 million worth of issued and outstanding ADS in open-market transactions, the company purchased approximately $1 million worth of ADS in the open market at November 15th, 2005. The company intends to continue to conduct further stock repurchases in the open market as allowed under the company's insider trading policy. This is a testament to our confidence in Linktone's promising growth outlook.
Now I would like to provide Linktone's business outlook for the fourth quarter of 2005. This outlook takes into account, among other factors, the continued anticipated impact on net income of increased product development and sales and marketing expenses related to Linktone's long-term strategic growth strategy.
For the fourth quarter ending December 31st, 2005, Linktone expects GAAP net income of approximately $0.15 per fully diluted ADS and non-GAAP adjusted net income of approximately $0.17 per fully diluted ADS.
For the full fiscal year 2005, Linktone expects GAAP net income of approximately $0.54 per fully diluted ADS and non-GAAP adjusted net income of approximately $0.63 per fully diluted ADS.
Now I will turn the call over to Raymond for his final remarks before we open the call up for the questions. Raymond?
Raymond Yang, Chief Executive Officer
Yes, Colin. Thanks. In order to maintain strong long-term growth and position in the market place, we have continued to focus on long-term marketing strategy and placed special emphasis on research and development of Linktone's next generation products and services. We have seen our investments in strategy begin to pay off in recent quarters as we continue to carefully monitor the use of capital and expenses and work implementing efficiencies as we knew our new products and services gain momentum.
Our newly acquires subsidiaries, Brilliant Concepts and Beijing Cosmos, have already begun to contribute to our total gross revenue and we firmly believe that our recent strategic investment in 9Sky will further cement our leading position in providing seamless music-related products and services.
Our primary focus is to maintain the right mix of investments and growth in order to continue to build shareholders’ value. We view ourselves as a growing and dominant leader in our market place and are excited about our entry into 2006.
And with that, we will open the call for your questions. Operator?
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