Linktone Q4 and Full Year 2005 Earnings Conference Call Transcript (LTON)

Linktone Q4 and Full Year 2005 Earnings Conference Call Transcript (LTON)

February 27, 2006

Executives

Michael Guangxin Li, Chief Operating Officer
Colin Sung, Acting CEO and Chief Financial Officer
Derek Sulger, Founder and Director
Him Tiem Foo, Deputy CFO

Analysts

Wallace Cheung, Credit Suisse
Chang Qiu, Forun Technology Research and Advisory
Michael Zang, Equity Partners
Ming Zhao, Susquehanna Financial Group
Patrick Lin, Primarius Capital

Presentation

Brandy Viacente

Thank you and welcome to Linktone’s regular quarterly conference call. With me here today are Mr. Colin Sung, acting Chief Executive Officer and Chief Financial Officer, Miss Him Tiem Foo, Deputy Chief Financial Officer, Mr. Derek Sulger, a founder and Director of our company and Mr. Michael Li, one of our directors and the former Chief Operating Officer of Linktone.

Earlier today, we announced our financial results for the Q4 and fiscale year ended December 31st, 2005. in addition, we announced in Friday that the company will be undertaking a management transition. To give our shareholders a full update on these events, Colin Sung will begin today’s call by first reviewing our recent business highlights. Second, our deputy CFO, Him Tiem Foo, will review our financials for the 4th quarter and full year 2005.

Third, we will provide our business outlook for Q1 ’06. then, Derek Sulger and Michael Li will discuss our management transition.

Lastly, and most importantly, we will open the floor up to 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 2006 and the anticipated impact of certain business events sucgh as changes in mobile operator policies, linktone’s recent acquisition of Ninesky international Limited and strategic investment in Ojava Overseas Limited on Linktone’s 2006 gross revenues and net income and outlook for Q1 2006 financial results. You can also identify forward looking statements by terminology such as will, expect, anticipate, feature, intend, plan, believe, estimate and similar statements. The accuracy of these statements may be impacted by a number of business risks and uncertainties that cause our atual results to differ materially from t hose projected or anticipated including risks outlined in our filings with the SEC such as our registration statement on form F-1 and 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 Colin Sung, Linktone’s acting CEO and CFO for a summary of Linktone’s business, financial and operational results for the 4th quarter and fiscal 2005. Colin?

Colin Sung, Chief Financial Officer

Thank you Brandy and thank everyone on the call for joining us today. Let me start by telling you how much I value the trust and confidence you have placed in Linktone. I look forward to further earning your trust as I lead the company through the management transition we announced this past Friday. All of us at linktone feel strongly that building shareholder value is our absolute top priority. Our directors and management clearly understand and are benchmarked on this goal. We have therefore decided to put in place a clear action plan for 2006 which we internally have called taking Linkton to the next level.

These involve focusing more clearly on our core business, increasing efficiency in all aspects of our business and executing more rapidly to build marketshare in promising business lines.

Our 2006 business plan reflects a prudent growth strategy for 2006. it also reflects a sense of urgency and aggfessiveness that we feel is necessary, given our disquieting 4th quarter results.

In the 4th quarter, we fell short on the top and bottom line. I hope to provide a clarity to our results and to communicate the measures we are taking to immediately address these shortfalls.

Hin keung will discuss in detail our 4th quarter financials, later in this call. But I will first give you a brief overview of the 4th quarter.

Gross revenues were $20.6 million, slightly higher than our very strong 3rd quarter and up 32%^ over the same period in 2004.

Total revenue for 2005 was $73.6 million, up 46% from 2004.

4th quarter US GAAP met income was $1.6 million or $.05 per diluted ADS, compared to $4.1 million or $.15 in the 3rd quarter of 2005 and $1.9 million and $.07 in the corresponding period in 2004. adjusted, net income for the 4th quarter 2005 reached $1.9 million or $.07 per fully diluated ADS, down 60% from the adjuted net income of $4.6 million, or $.17 per ADS in the 3rd quarter of 2005 and down 55% from $4.1 million in the same period in 2004.

For fiscal 2005, US GAAP income was $12.4 million or $.45 per fully diluted ADS< excluding the effect of non-cash, stock based compensation, which was incurred in 2005. adjuted net income for the year was $14.5 million or $.53 per fully diluted ADS, which was roughly flat earning compared to 2004.

We attribute Linktone’s strong revenue growth in 2005 to a continued increase in usage of mobile value added services by Chinese consumers. An increase in overall size of the Chinese wireless user base and a reflection of the TREO market opportunity presented in 2005.

We still believe the opportunities in the wireless internet sector present the most exciting area of growth in China’s internet related business. However, we are clearly not happy with the fall in net income that we experienced in the 4th quarter of 2005. hence, we would like to address the reasons for the shortfall upfront.

First, we suffered from ineffectiveness, related to certain major marketing campaigns. We believe this was due to the company’s being too aggressive with unproven marketing media, during a period where the competition’s access to effective marketing channels increased. Therefore, we did not effectively estimate the return on marketing spend forr these new programs.

Going forward, we are addressing this area of weakness by putting in place greater control of new marketing initiatives and are demanding greater return on spend from the marketing campaigns we undertake. We are pleased that Michael Li, who designed and has all responsibility of our marketintg initiatives during his tenure as Chief operating officer, will be available as a member and part of our transition team to help us directly address and manage these changes.

Second, we experienced a rise in G&A costs related to legal, audit and consulting work. This is an area where we feel a responsibility, both to our shareholders and as a public list company, to maintain adequate investment. This is clearly a and other requirements we face. However, we also feel that we can manage these costs better and more efficiently. Going forward, we have announced the promotion of Miss Him Tiem Foo to deputy Chief Financial Officer. Ms. Fu came to us after serving many years at Price Waterhouse Coopers and we are confident that she will continue to add value on many fronts. And in particularly, assist us in focusing on controlling costs related to these areas.

Third, we experienced a greater than expected rise in headcount related payroll costs. This is a result of a torrential pace of growth we have witnessed in our industry and our company. However, even with linktone’s 46% rise in gross revenue for fiscal 2005, we must always be mindful of maintaining a lean organization. Going fofwward, we anticipate reduced headcount related payroll expenses in the near term. This process is already under way within the company, as we have made the difficult decision to terminate certain managers who have either underperformed in their capacity or are in business units which do not justify investment in the current climate. In addition, we anticipate transitioning a signficnatn number of our key managers onto compensation plans with a greater incentive-linked component. As one example of that, I have personally accepted a reduced base salary as part of my 2006 compensation package and have agreed to forego any fixed bonus payments in exchange for payments linked to company’s EPS and revenue. I anticipate other new executives, including my permanent successor as CEO, to accept similar packages which are far more weighted to variables, milestone-linked compenstaiton.

Lastly, we experienced higher product development costs related to three specific areas. Online casual games, pay java gamaing and WOP. Going forward, we continue to believe that linkton must invest peers in key growth areas. At the same time, we also believe that linktone must remain focused that are clearly aligned with our core strengths. Therefore, we forecast decreasing R&D dollars to be spending on online casual games, except for those directly related to areas where there is a high degree of overlap or synergy with our wireless gaming initiatives.

We also forecast additional investmtnet in k-java gaming which will be leveraged through our researched strategic investment in O-Java and the team of experienced personnel we have brought into the linktone family, lead by O-java CEO, Roger Shu. We continue to believe that Linktone can make great strides in climbing up the tables in the wire business. We will contue to invest in this in order to accelerate this positive trend.

Now that we have discussed expenses, I want to turn to some of the positive developments that the company is currently experiencing. Recently, we announced our stratetic investment in O-Java, China’s leading mobile game developer and game publisher. O-Java currently ranks third in the delivery of java based games to Chinese mobile consumers. We believe the combination of O-Java, experienced product development team and the linktone strong and offdeck distribution channel will enable us to secure a leading position in the fast growing mobile game market in China. We believe this market will be one of the next growth drivers for china’s wirelesss industry and china’s mobile gaming secotor is expected to experience significant revenue growth in the coming years. Additionally, we see WOP as a growing catalyst for our topline going forward. Linktone faces the challenge of restrating this business due to a effect in 2005. but also the opportunity of starting from a low base with plenty of room for growth. We have made aggressive inroads in WOP marketing and product development this quarter. Two clear early stage signs of progress as follows: first of all, we believe that our Wop ranking with China Unicom has now risen to number three, behind two of our distinguished peers – array and . But rising from number ten at the end of third quarter. Second, we have restored WOP services to China mobile users in the 4th quarter of 2005 and have egun to build a meaningful WOP business in this sector. While the total WOP business for linktone is a small percentage of total revenues, we clearly see this as an above average growth trend going forward. We also see other opportunities. We have concern about maintaining margins and controlling expenses in a competitive marketplace. We know the

First of all, linktone is amongst a relatively small subset of our peers that experienced strong, wireless revenue growth in 2005. second, the size and the breadth of china’s wireless market continues to expand with strong new mobile user growth increasingly spending more money overall for more mobile services. Third, an increasing number of new technologies are opening to wireless value added services, driven by music, , 3D, PHS, video on demand and other emerging technology. Fourth, China remains a mobile centric internet market with the majority of internet related revenues amont the largest companies coming from mobile services. The challenge for linktone, therefore, is to remain deeply focused on our core wireless business and to make wise choices about when and where to invest in American technology.

We believe that our team and the initiatives we have underway, place us in a good position for the coming year. And we are all looking forward to taking linktone to the next level. Now I will turn the call over to my colleague, our deputy chief financial officer, Miss Him Tiem Foo, for a more in depth review of 4th quarter and fiscal 2005 financial results.

Him Tiem Foo, Deputy Chief Financial Officer.

I’m pleased to join the call today and look forward to communicating more with our shareholders and analysts in the future. I’d like to give a quick rundown of certain financial highlights from today’s earnings results.

Linktone’s 4th quarter gross revenues were $20.6 million a slight increase4 from the 3rd quarter 2005. 4th quarter refvenues resulted from a steady diversification across a wide variety of product areas including MMS, WOP, IPR and RBT. The company’s gross revenue fro fiscal year 2005 rose 46% to $73.6 million, compared to $50.3 million this quarter for 2004. average amount of paying users for the 4th quarter was approximately 7.8 million a fall from the peak 8.3 million reached during the 3rd quarter as a result of our supergirl promotion, but still above the 7.3 millioin users at mid-year 2005.

Average money revenue per user for the 4th quarter was approximately $.71 per month, unchanged from the previous quarter.

Linktone’s gross margin for the 4th quarter of 2005 was 58% of net revenue, or gross revenues minus business tax, compared with 61% for the 3rd quarter of 2005 and 68% for the 4th quarter of 2004. the decrease was due to increased revenue share payments to content providers and service for marketing partners.

Operating margin was 7% of net revenues, compared with 19% for the 3rd quarter of 2005 and 13% in the 4th quarter of 2004. the decrease was mainly due to certain marketing programs failing to produce antici0pated topline revenue returns.

4th quarter operating expsense were $10 million or 51% of net revenue, compared with $8.3 million or 42% for the prior quarter.

Our 4th quarter net income under US GAAP was $1.5 million, down 64% from the $4.1 million for the 3rd quarter. Linktone’s net margin was 7% in the 4th quarter, compared to 21% in the previous quarter. GAAP earnings per fully diluated ADS was $.05, a decrease from $.15 in the third quarter. Adjusted net income for the 4th quarter was $1.9 million or $.07 per fully diluated ADS. This with adjusted net income of $4.6 million or 17%, up $.17 per fully diluated ADS, excluding one time non-cash expense for stock compensation in the 3rd quarter.

Fully year net income under GAAP was $12.4 million or $.45 per fully diluted ADS compared to $11.1 million or $.41 per fully diluted ADS for the year earlier.

You’ll find the reconciluations of GAAP financial measures to Non-GAAP financial measures in our financial statements on 3rd quarter results. We shall post it on linktone’s website at www.english.linktone.com. Also please note that as disclosed in the earnings release, 2004 amounts have been restated to reflect certain non-cash stock based compensation expenses.

I now want to run through a few balance sheet items. We had cash and cash equivalent as well as short term investments help to maturity, totaling $78 million. In the 4th quarter we generated positive cash flow from operations of $8.5 million, higher than the $.7 million for the 3rd quarter of 2005, due to the fact of collection of accounts receivable from certain mobile operators toward the end of the year and certain tax refunds received.

The number of weighted average ADS for the 4th quarter was 27.9 million from 27.7 million for the 3rd quarter. As of December 31st, days sales outstanding was 105 days, compared with 94 days in September 30, 2005. many due to delays arising from the October national day holiday, which fell during this quarter.

Lastly, I would like to discuss our share repurchase program. Having received shareholder approval in September 2005 to buy back up to 50 million ADS in open market transactions, the company has purchased as of today, 608,700 ADS for total purchase of approximately 6.4 million. These shares will be retired under the company intends to continue to conduct further stock repurchases in the open market, as allowed under the company’s insider trading policy.

Lastly, I would like to give some clarity regarding the expenses discussed by Colin as part of our 2006 business plan. The company’s current dirve for efficiency will result in certain one-time expenses related to severance payments and other related costs. We expect to take these one time expenses in the first quarter of 2006,l however, we will expect to see the impact both for and both initiatives beginning in the 2nd quarter of 2006. now I’d like to turn the call back over to Colin for discussion regarding our first quarter 2006 outlook.

Colin Sung, Chief Financial Officer

Thanks Him Tiem. Now, I would like to provide linktone’s outlook for the first quarter of 2006. 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 growth strategy as well as one-time personnel related charges and assuming no adjustment for US Dollars and exchange rate fluctuation on current levels.

Linktone anticipates revenue will be at least $21 million for the 1st quarter of 2006, reflecting our expectation of rising revenue in linktone’s business segments.

Linktone’s non-GAAP adjusted net income of approximately $.09 per fully diluted ADS, excluding certain one-time expenses or charges.

Lastly, linktone expects GAAP net income of approximately $.08 per fully diluted ADS.

Now, before opening the floor for questions, I would like to turn the floor over to one of our founders and the board director, Derek Sulger, to discuss other aspects of the management transition we have underway.

Derek Sulger, Founder and Director.

Thanks Colin. First off, on behalf of the board of directors of the company, I’d like to extend all of the company’s thanks to Raymond Yang, our outgoing CEO, who has served the company with a tremendous degree of leadership, integrity and success over the past 3 years. I’d also like to extend my gratitude and full support to Colin Sung, our acting CEO and CFO. And also to Michael Li, our newly appointed Director and as many of you are aware, linktone’s former COO.

I am sure that many of you on this call have been as impressed as I have with Colin’s grasp of our company’s business and as well with Michael Li’s operational understanding of Linktone and of the China wireless landscape. I believe that Colin is the perfect person to lead this company through the current transition and that Michael will bring us invaljable operational knowledge and leverage.

Now, I’d like to give some additional color regarding the transition that we announced on Friday, and some of the decisions that were made by the board of directors.

The purpose of this transition that the company is currently undertaking is to accelerate the implementation of our 2006 business plan and simply put, to take linktone to the next level.

The board of directors believes firmly that now is the right time to take ht prudent steps associated with carrying out a transition to increase operating efficiencies, explore new opportunities and renew our focus on building shareholder value. Additionally, the directors firmly believe that China’s furutre is a wireless future and that linktone has an increasingly significant role to play in addressing this market. Solidifying our vision for how linktone will address the growing wireless marketplace and tightening up our execution plan are the best ways that linktone believes we can deliver shareholder value, which is the single most critical metric for everybody participating on this call.

Procedurally, we have asked Colin Sung to serve as acting CEO, while we implement this transition. We have promoted Him Tiem Foo, to assist with CFO related functions and are actively involving all of our other managers, including Richard Shu, and Li Yeung Du, who were recently announced as our new senior vice president of operations and our cie president for sales and marketing.

We believe that this transition will proceed very quickly and anticipate appointing a permanent CEO as soon as possible.

Lastly, we believe that this process requires a dedicated resource at the board of directors level to ensure smoothly and transparent transition. To that extent, the board has formed a transition management committee to work with Colin on a real-time basis. Michael Li will be playing a leading role on the transition management committee, alongside myself, and two of our other directors, June Wu and David Wang.

Many of you know Michael Li, so at this point we planned on turning the floor over to him for a few comments about his new role. However, due to a minor surgical procedure he was having today, he asked me to say a few words on his behalf.

Michael has been a member of the Linktone family for over 3 years and will now be joining the board of directors and aiding this transition in helping achieve our goal of taking linktone to the next level. Michael and I both firmly believe that the key to linktone’s future is to affect this transition as quickly and smoothly as possible, to clarify linktone’s vision for the China wirelss marketplace and to increase operating efficiency and our speed of execution at every level.

I am confident that michael’s experience as a member of the management team as well ashis overall expertise in China’s wirelss and internet markets will aid the board and aid management in making the critical choices necessary to meet these challenges. I also hope that Michael joining the board of directors conveys to you, our shareholders and our analysts, his excitement about the company and linktone