TOM Online Q4 2005 Earnings Conference Call Transcript (TOMO)

TOM Online (TOMO)
Q4 2005 Earnings Conference Call
March 17th 2006, 7:00 AM EST

Executives

Rico Ngai - Senior Manager Corporate Communications
Wang Lei Lei - CEO
Jay Chang - CFO

Analysts

Michael Jung - SG Cowen
Safa Rashtchy - Piper Jaffray
Jan Ho
Nat Schindler - Piper Jaffray
John Bai - Credit Suisse
Ming Cheng - Calyon Securities
James Lee DE Investment Research
Wallace Cheung - Credit Suisse

Presentation

Operator

Good day, everyone and welcome to the fourth quarter and fiscal 2005 results conference call. (Operator instructions) I would like to hand the call over to Mr. Rico Ngai and I will be standing by for the Q&A session. Please go ahead. Thank you.

Rico Ngai

Good evening and good morning, ladies and gentlemen. Welcome to TOM Online 2005 fourth quarter and annual results investor conference call. With us today are our Chief Executive Officer, Mr. Wang Lei Lei; and Chief Financial Officer Mr. Jay Chang. Mr. Wang will give you an overview of the Company's business in the fourth quarter 2005. Mr. Chang will provide you with financial analysis of the corresponding period. The presentation will be followed by a Q&A session.

Before we proceed, I would like to bring your attention to the fact that the following presentation contains statements that may be viewed as forward-looking statements within the meaning of the Securities Act of the United States. For details, please consult page 2 of the PPT on your computer screen.

Now, ladies and gentlemen, please welcome Mr. Wang.

Wang Lei Lei

Good evening and good morning to you all. Thank you for your interest in TOM Online, our full year 2005 and fourth quarter results. I am very pleased to report another solid quarter of performance from TOM Online. Our fourth quarter revenue exceeded the top end of our guidance range, reaching $48.1 million. This represents year-over-year growth roughly of 5%, increased from the third quarter. We believe this continues our position as the leading wireless Internet company in Mainland China.

More importantly, fourth quarter net profit was $12.7 million, a little bit of a decline but it is representing 55.1% growth from the same period last year and excluding the $1.1 million gain in third quarter due to RMB appreciation. Growth roughly 8% quarter on quarter.

Next page, this is the whole year. We achieved $172.1 million in revenues, a 40% year-over-year growth, which includes $161.9 million in wireless internet revenue, and $9.2 million in online advertising revenue. In 2005, whole year net profit reached a record high of $25 million, over 30% growth year-over-year and also we surpassed our [outcome projection] for the bottom line.

Next slide, I believe that these achievements are due to our strategy, our focus on being the leading wireless Internet company in Mainland China. In China, we continue to believe that consumer facing business such as ours still have great potential as we are targeting more than 100 million Internet users, but more importantly, 400 million mobile subscribers.

In the China market, the three scalable new media business, in our opinion, are online advertising, wireless services and online games. TOM Online's strategy is to maintain our dominant position in wireless, around our Internet portal to support our wireless business. For our online properties, the targets are young and trendy markets and continue to leverage our online platforms to help incorporate content and applications from a wide variety of internal and external results. These range from traditional media and the music labels, with a focus on entertainment and sports content to web-based services such as email, blogs, and TOM Skype, all of which we believe should be able to be delivered to mobile devices through TOM Online in the years to come.

Also through our industry-leading wireless distribution platforms, we enhance our mobile operators partners existing sales channels and technology. By leveraging our relationships with TV, radio, handsets and other online media partners, we believe that compared to many of our competitors, we have a more comprehensive offering for not only content owners and mobile operators, but more importantly for our end users.

Lastly, I continue to be proud of our team's execution ability and reputation, which have helped us attract and maintain more strategic partners across the industry value chain. I will stop here and let Jay give you more details on our financial results.

Jay Chang

Thanks, Lei Lei. If you turn to page 8 if you have the presentation. Before I go into the financial results, just two key points. One is, in the press release we provide a fairly detailed analysis of each business line in wireless as well as online advertising, so I won't go into details too much on the call except for on the Q&A, and then for your reference, within this presentation the appendix section, there is a revenue breakdown by SMS, MMS, WAP, IVR, ringback tones, so on and so forth, for your reference.

So on page 8, for the fourth quarter we achieved total revenues of $48.1 million which is about 5% of quarter on quarter increase and about 40% over the same period last year. More importantly, gross profit margin stabilized and actually increased slightly to 44.4% in the fourth quarter from 44.1% in the third quarter. A big contribution to the stabilization and slight increase in gross margins was due to higher revenue contributions from our online advertising business, which has higher margins than our wireless.

EBITDA for the fourth quarter was $14.2 million with EBITDA margin very close to 30% quarter on quarter, and slightly up, same reason, due to our online advertising contribution.

Total net profit for the fourth quarter was $12.7 million and excluding the $1.13 million gain in the third quarter from the RMB appreciation, we actually increased net profit about 8% quarter on quarter. On a fully diluted ADS basis, we did $0.24 based on 53.3 million shares.

One of the key reasons that we continue to believe we have a great position in the market is really our diversity across the value chain in the wireless internet business, regardless of the different technologies or different sales channels. We believe we have a dominant and we continue to find ways to increase our market share across the market.

In terms of the fourth quarter, in terms of the key revenue drivers for our business, there were three main ones. The first was MMS grew about 43% quarter on quarter from the third quarter, as we have seen the impact from the mix migration early in 2005 stabilize, and we are seeing a rebound now in the MMS business.

For our IVR business, we grew roughly about 3.5% quarter on quarter, but this was a slightly -- it could have been actually higher in terms of revenue growth for IVR business, as during the November time period we actually moved data centers, and experienced some slight, temporary technical glitches as we did that migration. That issue is over now and we look forward to better growth opportunities in IVR in 2006.

More importantly, our online advertising grew almost 25% quarter on quarter and increased as a part of our overall total revenues from about 5-6% in the third quarter to 7%, as we've seen a lot more interest from existing advertisers as well as new advertisers as our sales activities focus on more strategic channels on our portal, including music, entertainment, auto and sports continues to pay off.

In terms of operating expenses, I think the key variable that we saw from the third quarter to the fourth quarter was our sales and marketing increase. The incremental $1 million that we spent in the fourth quarter was really due to a number of seasonal activities. Firstly, we continue to promote Wanleba across 30 universities in China to better brand our target audience with mobile and music more closely.

In addition to that, at the year end we held our entertainment gala which brought together numerous Internet singers as well as pop stars and movie stars to also continue our branding as an entertainment online leader in China. As usual, similar to the fourth quarter of 2004, we seasonally increased overall branding advertising such as bus ads and billboards across the country.

On page 11, just for some housekeeping, we ended 2005 with roughly $124 million in net cash on our balance sheet. However, in the first half of '06 we will pay out about $16.6 million to complete the acquisitions and earn outs of Treasure Base based on their 2005 audited accounts. In the first quarter, we acquired and completed an acquisition of an online literature portal that aggregates user-generated content for authors around China, a company called HJSM for about $2.6 million, which we paid in the first quarter. About $1.2 million of that is going back into the Company as paid-in capital to fund their growth opportunities. Lei Lei will talk a little bit about how that fits into our overall strategy.

On that, I will turn it back to Lei Lei.

Wang Lei Lei

On page 13, as you know TOM Online has built a powerful device [by the] sales platform, which includes alliances and assets online to offline, and the traditional media for new media. In the second half of 2005, we focused on developing our TV alliances. What has been interesting is that many people have questions about the sustainability of our TV cooperation strategy, because many of our competitors negative outcome with advertising wireless services on TV. Actually, TOM Online's strategy is entirely different.

In our alliances, we insist on a revenue-sharing model with TV operators which prevents us from being exposed to unmanageable upfront advertising costs. From an operational level, we actually work very closely with our TV partners operation and the TV production teams to integrate our wireless services into their programming advertisement.

Also, our own CRM system, we help drive more interactivity and sales efficiency for both TOM Online and our TV partners. We believe that this operational model is different from many of our competitors, and as our scale and apparent growth in this area, thus our market positioning will only get stronger.

Looking out towards 2006, we are very happy on the outlook for the wireless Internet. From the carriers point of view, we believe operators like China Mobile continue to revise their wireless strategies to work on more transparent operating environments with a focus on building more close and strategic relationships with fewer larger players like TOM Online, which we believe will raise the barriers of entry for many smaller players.

For the content side, music and sports will be a focus for us this year. In the fourth quarter, roughly 50% of our wireless revenues came from music-related products. However, also in 2006 to take advantage of the interest in the FIFA 2006 World Cup, we will also develop our sports content and services, and believe that our exclusive relationship with CCTV 5, which is the largest sports TV channel in China, and our ongoing relationship with Sports Weekly, which is China's largest sports magazine, will drive forth as another major content category for wireless. This is another example of our wireless distribution alliances; we recently announced exclusive alliances to offer wireless services to Ourgame which is a large online game community.

Let's talk about 3G. The timing of the 3G license in China remains variable. We at Tom Online are already busily preparing and coordinating with our key partners so that we will be well-positioned for the 3G as space becomes mass market, like over the next 12-24 months. This includes our ongoing commercial services to our partner company, Huawei in Hong Kong, but more importantly, China Mobile. Where we are helping define next-generation technologies and the media around mobile devices for the coming 2008 Olympics and are actively conducting and learning from the pilot 3G projects, which various China Mobile provincial operators, including the Guangdong Mobile.

There are some features for the new business update for the TOM-Skype JV. We continue to actively grow the TOM-Skype user base and seek ways to differentiate Skype services from the Mainland China market, which takes advantage of its scaleable peer to peer model. At the end of February, we had over 9 million registered users for TOM-Skype, up from 5.2 million at the end of October when we last presented our third quarter results. In addition we have been working closely with the Skype team to develop the value-added services such as TOM-Skype radio to provide the end user and Wanleba community with voice-based music services and premium IVR services over Skype.

We continue to pursue some ways to develop new services which TOM-Skype users may be willing to pay for, but in the near to medium term, the primary focus is on growing the user base and developing the free services which will give users more loyalty.

Our strategic alliances with UMPay continues to be a longer term opportunity for us. As such, for most of 2006 we will seek to jointly develop and enhance the user experience and business plan with UMPay while they continue to build out the infrastructure and the platforms to enable users to connect their banking cards with their mobile phones and conduct payments.

During the fourth quarter, we conducted a small scale pilot whereby users could use their mobile phones to pay at selected restaurants in Beijing. Moreover, in addition to our bank card access and offline payments, we believe the area of micro payments which is using the mobile phone to bill directly to the payments. And UMPay to pay for virtual and real goods online, is another bright area which we are actively developing with UMPay currently. At the end of 2005 UMPay had roughly 6 million subscribers and over 200 merchants already signed up on their platform.

So let's talk about outlook. Jay.

Jay Chang

Before we get into Q&A for the first quarter of 2006 we are guiding for a total revenue range of $47.7 million to $48.5 million which is relatively flat growth quarter on quarter. However this is roughly 35% to 37.5% year-on-year growth over the same period last year, first quarter '05. This does imply roughly about a 15% to 20% sequential decline in our online advertising business as 1Q is historically a weak quarter for online advertising.

On that note, operator we'll open to questions. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) The first question will be coming from Michael Jung - SG Cowen. Please go ahead sir.

Michael Jung - SG Cowen

Hi, good evening.

Jay Chang

Hi Michael.

Michael Jung - SG Cowen

Hi. Congratulations on a great quarter. I have three quick questions. The first is for Mr. Lei Lei Wang. As the Chief Executive of the largest WVIS company in China, what is your view on the overall market in 2006 and beyond? Based on your best knowledge, what should investors pay attention to in this year, either on the positive side or on the not so positive side in the market?

Wang Lei Lei

From my viewpoint China Mobile for 2006, we will change a little bit about their operating strategy with the service provider. Just like before, they don’t want to open market to have all cooperation with all service providers, big or small. They just want to close strategic relationships with big service providers, the key player like TOM Online and Sina and KongZhong in terms of the revenue side. That means we can get more benefits and get more resources from China Mobile and also the local carriers.

For this year, China Mobile with the focus on developing a 2.5G and VoIP-based services which is our advantage. We have more advantage for the new services and focus on core selling strategy. This is what we mentioned one year ago to China Mobile to leverage the big volume from SMS from all the new business like 2.5G and ringback tones.

Also, China Mobile was very focused on developing music and sports-related content. Music is the biggest revenue contribution. For example, for the fourth quarter it's about a 50% revenue contribution for the wireless coming from the music-related products.

For the sports for this year, we hope to work together with China Mobile. We will have seasonal revenue in Q2 for the FIFA 2006 World Cup and we just provide our two exclusive traditional field channels from CCTV-5 and Sports Weekly to cooperate with China Mobile about some offline and online cross-selling during the 2006 World Cup.

This is all to show our strength, that we just combined our strategy with China Mobile and also we have many of the advantages from the products and field channels.

Michael Jung - SG Cowen

In the market, is there any trend that is not so positive that investors should be paying attention in '06?

Wang Lei Lei

I think in '06 the China Mobile will have many regulations to add more transparency for the industry. But, this is very healthy for us and for the big players in the market. For some small ones which is not a very balanced revenue structured company, it can hurt some companies' P&L.

Michael Jung - SG Cowen

Okay, thanks. My second question is, just because of [ST]'s position the margin squeeze is kind of inevitable, to fight back some of your competitors move upstream to become a content provider. TOM has been doing a great job to diversify the distribution channels.

My question is, in 2006, other than the current Wanleba initiative and also the recent acquisition of Onegame and [Chumong] do you have any other plans to increase your ownership of the content? Do you expect support from TOM Group, which owns a lot of content?

Wang Lei Lei - TOM Online Inc. - CEO

We just maintain the whole [wide area] channel, which is we have the good relationship, partnership with low content providers like Music Label Company which have 50-50 revenue sharing. We don't want to make any acquisition for the low content provider from traditional music labels, which has maybe broken up the value chain.

[Chumong] is the acquisition has two meanings. One is just to leverage their traffic to the base to enhance our portal strength. The second is for this year, we want to have a trial to migrate many of the portal-based content, self-created content from the online music venture to the mobile platform. Compared with Japan, the portal-based online mobile [integrated] services is very popular in Japan. We don’t want to acquire any of our partners from the value chain.

Also last week, we just connected some key players from the service provider to the corporate-wide alliances. That means we just cooperate together with some of our competitors to have more bargaining power to the music labels. We don’t want to change the revenue-sharing model with the label, we just keep the revenue-sharing model with music labels.

Michael Jung - SG Cowen

Okay, yes that’s good enough. My last question is for Jay. I think you mentioned gross margin was better in 4Q because of online advertising and the sales and marketing expenses is also higher due to seasonality. Are any of those indicative in the future quarters?

Jay Chang

Sorry, what do you mean by indicative?

Michael Jung - SG Cowen

I mean are they the run rate for the future quarters?

Jay Chang

Well, as I mentioned in our guidance, because first quarter is seasonally very weak for online advertising and online advertising has a higher gross margin than our wireless business, you should expect our gross margins to come down in the first quarter. But then hopefully after the second and third quarter and the rest of the year, online advertising hopefully will rebound as per the industry. In terms of sales and marketing, yes, 4Q is really a high for the year as well as going into the first part of '06.

Michael Jung - SG Cowen

Okay, thank you very much.

Wang Lei Lei

Thank you.

Operator

Thank you sir, does that conclude your question?

Michael Jung - SG Cowen

Yes.

Operator

Thank you very much, sir. The next question will be coming from Safa Rashtchy. Please go ahead, sir.

Jay Chang

Hi Safa.

Safa Rashtchy - Piper Jaffray

Yes, thank you. A couple of questions. First Jay, on your guidance, the guidance I believe you said implies about 35% year-over-year growth, a fairly significant slowdown from the 40% plus that you have been having over the past couple of quarters.

Aside from online advertising, which is still a fairly small component of your revenue, what is accounting for this? Are we seeing overall a slowdown in the growth rates in wireless services, or is there something particular about Q1?

Jay Chang

Well, I guess from our side, our 35 to 38% range is not that far from 40%. So I don’t know if I understand your question on the first part. In the first quarter, you do have to remember there's a number of things that are happening in the first quarter. One is the shorter quarter in terms of days, our business is a daily business, so we have about 2% or 3% less number of days.

On top of that, in the first quarter you have Chinese New Year which not only impacts online advertising in terms of usage of Internet, but also, people travel home to spend time with their families so there is less time in front of TVs and so on and so forth for our general businesses.

On top of that, on March 15 there is something called Consumer Day which is something that basically the government and all the industry players adhere to and listen to, what the consumers' [write]. At that point in time we need to be relatively more sensitive to marketing and to other types of promotion.

So all these things we take into account into our wireless business, but on top of that we also have a seasonal decline in our online advertising business.

Safa Rashtchy - Piper Jaffray

My point is that all of these things, such as Consumer Day, were also there last year. My question really is, if you do go to the low end of your guidance at 35% that would be material decline. Are you seeing any decline in terms of the growth rate of any of the wireless activities?

Jay Chang

Well they vary quarter to quarter, but I think year over year we still see a lot of opportunities, especially in 2.5G services as we're allying ourselves with China Mobile this year. We do believe as we get into the second quarter of the World Cup events, as we saw with NBA championships with Yo Ming in there, with CCTV-5, to that second quarter of 2005, was a good period for us.

On top of all that, we're actively looking at opportunities with Unicom, they're opening up their GSM user base which is about 100 million subscribers. On top of that the [Chen Jou Shing] building upgrade for prepaid China Mobile is still ongoing. So it's actually a lot of secular opportunities.

On top of all that, I think China Mobile themselves increased their CapEx budget for 2G investments this year as well as '07 quite significantly, I think showing that the end user subscriber growth, which is still for users that are using SMS and IVR, have I think still a lot of potential.

As we get to a law of large numbers, we're basically double our nearest competitor. You should expect some type of relative slowdown, but I think overall 35% to 37% plus is something that from our view is still quite positive.

Safa Rashtchy - Piper Jaffray

Okay, great thanks. A quick follow up. I'm not clear on the marketing expense that you had in Q4 which was more than maybe you expected. What was the purpose of that and what did you accomplish with that?

Jay Chang

I don’t know if it was more than what we expected, it's something we've been budgeting all along. We're unable to give that much clear guidance below the line because of our [GEM] listing. But what we accomplish by that is we reached, for at least Wanleba, roughly 250,000 people a very targeted audience across universities across China, about 30 universities.

On top of that, we annually always hold some type of major event. At the end of 2004 it was a sports event to celebrate the Olympic champions of China, and this year it was like an Oscar's event for the new media industry which we thought went over very, very, very well.

In terms of what we accomplished is, it's very targeted marketing to our specific users which are younger and wireless users and we want to keep branding ourselves as the wireless Internet leader in China.

Safa Rashtchy - Piper Jaffray

Okay. One last question if I may. Could you tell us what you're doing in the 3-WAP portal? What kind of progress are you seeing in that and what is your strategy in there?

Wang Lei Lei

For the long term vision the China Mobile cannot stop developing the 3-WAP portal because some cases it started from the fixed line before Sina WAP service came out, the major WAP service used to come from the fixed line carriers operation team. But after Sina came out this disappeared.

So the second thing is from the government angle, they don’t want the carrier to be as the new media operators, and for WAP services in terms of the user growth -- and it's more like a new media, the WAP portal -- and the government will not want the carrier to run a media portal.

So we have great opportunities from like Sina, Sofu, TOM Online, the other Internet companies which have strong internet brand coverage and traffic user base, they are doing well for the wireless WAP portal than the other service providers and the carriers' own portal.

So now for this year we have a 20 people team to operate the WAP of tom.com and we just migrate the entertainment, music and sports-related content to our portal and entertainment content applications.

Safa Rashtchy - Piper Jaffray

Okay, thanks Lei Lei. Thanks Jay.

Wang Lei Lei

Thank you.

Operator

Thank you. And does that conclude your question?

Safa Rashtchy - Piper Jaffray

Yes it does.

Operator

Thank you very much. The next question will be coming from Jan Ho from the US. Please go ahead, sir.

Jan Ho

Hi, Jay and Lei Lei, this is Jan. I have two questions. The first one is, early this year I went back to China and I've been told by several services providers that China Mobile told them stop using SMS as a marketing tool to market their wireless services. I got information about TOM and you said you didn’t get any notice from China Mobile. I wonder if that is still the case and if so, what's going to happen early this year, like the first half? Will that happen?

Wang Lei Lei

I think it's not exactly right, because we have had communication with China Mobile. They just let us have some interactive with our existing mobile pay users. We just use a cross-selling strategy to leverage our big volume of SMS to promote our 2.5G services including WAP and MMS services. We leverage SMS to promote our IVR services.

I think the rule is that you only can give some promotion message, WAP push services to your existing registered users, you cannot use this kind of promotion to the users which are not your registered user.

So TOM Online have over 70 million registered users for mobile services, so we have a bigger user base than the others. So for the small player, they really have no adding to the base, they cannot send their SMS to the new users if they don’t have any registered records.

Jan Ho

My second question will be in the music area. I sense that a lot of service providers realize music is going to be a big deal in China, particularly the wireless music. I see a lot of service providers enter into this area. I assume the competition for you is going to increase. What is your strategy against that kind of competition and to defend your own territory?

Wang Lei Lei

I think because it's about 50% of our fourth quarter wireless revenue coming from the music-related products, I think the barrier to prevent some small competitor to break into the market is we have more [inaudible] and powerful sales channels than the others. Also we have more powerful back end technology value-added service platforms than the others. Like [Paray], he's about 60% revenue of their revenue is coming from the WAP but they are very weak in SMS, Fuji services and voice-based services. Like [Lin Tung] they only focus on the other SMS based services, their WAP services was bought by China Mobile.

So we have more balance, the value-added service channels than the competitors and also we have more diversified sale channels than our competitors. Music labels like to cooperate with us who can get more benefits from the market to our partners.

Also from the China Mobile, they want to have the good relationships and give us some more resources for some local carrier-based resources than the small service providers. So this is our chance from the CRM strength, from the sales channel strength and from the strategic partnership with the carrier strength.

Jan Ho

Okay. My last question will be the SMS area. The SMS area in the past, the margin was squeezed by content providers, by operator and they enter into '06 and we see a lot of services providers who didn’t provide SMS or who weren’t focused on SMS now entering into SMS.

So we're going to see some competition, more competition come from service providers. I believe under these circumstances, the margin of SMS will be further squeezed. I want to get a sense of what you think about it.

Wang Lei Lei

The SMS market is a growing, mature market. SMS user penetration has reached almost 70% of the total mobile subscribers. For '05, we will have single-digit growth for SMS revenues, but this is all reliant on the confirmation rate. It's higher after the SMS platform migration in the first two quarters of '05 and we believe SMS for '06 is still a cash cow, but not a growth driver.

Our growth is very difficult to separate the SMS, wireless business gross margin. We believe our wireless internet business gross margin is stabilized because we still have revenue sharing with our content provider and the revenue sharing with sales channel owners.

Jan Ho

Okay, thanks.

Operator

Thank you. Does that conclude your question ma'am?

Jan Ho

Yes.

Operator

Thank you very much. The next question will be coming from Nat Schindler - Piper Jaffray. Please go ahead with your question.

Nat Schindler - Piper Jaffray

I want to ask quickly about the recent change in policy from the carriers on how they are going to charge the wireless service providers in cases of disputed or fraudulent billing. Will that have any financial impact on you? Or, was this mostly from the much smaller players in the space?

Additionally, I was wondering on Skype, whether or not the recent talk of blocking Skype at the telecom level would have any effect on your JV with eBay?

Wang Lei Lei

This is the question - why do the carriers want to change their strategy? They want a close and strategic relationship with the key players in this market. As you know, 10% of the service providers own over 80% of the market share. Another small service provider owns about 90% with the user complaints. That means carriers takes more management costs to have the cooperation with 2,000 service providers like SMS. From SMS to IVR, I think the carrier is an entry barrier to prevent the small player outside the value chain.

SMS is about 2,000 service providers so 2.5G business is only lower than 200 service providers, and for the voice-based services is lower than 100 service providers cooperating with China Mobile.

So this is the major reason why China Mobile wants to revise their strategy, because they just want to prevent the user complaints and make reductions about their management costs for the service provider. The other reason is they just want to leverage the content and the sales channel owners, which is integrated from the Internet portals.

For the second question for the Skype, it is not clear. The carrier wants to block any P2P service. Last week some of the fixed line major carriers in China announced that they never want to prevent or block some P2P services like Skype, like BT and other services. So carriers have a clear announcement.

Nat Schindler - Piper Jaffray

Thank you.

Wang Lei Lei

Thank you.

Operator

Does that conclude your question sir?

Nat Schindler - Piper Jaffray

Yes.

Operator

Thank you very much. The next question will be coming from John Bai - Credit Suisse. Please go ahead.

John Bai - Credit Suisse

Good evening, Lei Lei and Jay.

Wang Lei Lei

Hi.

John Bai - Credit Suisse

Yes I have a few questions, the first one to Jay. Jay, can you break out the gross margin for the advertising for wireless service like Sina your peers did in their report?

Jay Chang

We don't break it out on a quarterly basis.

John Bai - Credit Suisse

Can you break it out on an annual basis?

Jay Chang

Our online advertising revenues, the gross margin is roughly in the 60% to 70% range and wireless is roughly in the 40% to 45%.

John Bai - Credit Suisse

Lei Lei, a question for you.

Wang Lei Lei

Can you use Mandarin?

John Bai - Credit Suisse

Okay sure.

[Question asked in Mandarin].

Wang Lei Lei

[Response in Mandarin].

John Bai - Credit Suisse

Okay.

Jay Chang

I should probably just translate that really briefly for everybody on the call. The question was related to the unifying of SMS short codes by the MII. It's something that we are aware of. The MII is considering, it's not definite but if they do do it, it will be something going from four digits to eight digits but it's definitely something that we're coordinating with them.

If it does happen, it's probably something that will take about a year to a year-and-a-half where we'll actually have a parallel system in place to make the migration smooth for all the SPs. The main reason also is to make sure that there's not a huge confusion on the consumer side where consumer complaints can increase too much. Just in summary.

Wang Lei Lei

Is it better for the members upgrade? I think some small service provider will care about that but it's a two-year thing.

John Bai - Credit Suisse

[Question asked in Mandarin].

Wang Lei Lei

I think it's very difficult to comment on the rumors but as mentioned before, our major competitor is still coming from the major internet portals which have the brand coverage, traffic, user base because we believe the migration and the combined between the fixed line, internet portal and the wireless platform will be more important in the future.

We will like Sina, like Tencent, we just have the big Internet assets. But the other big thing is that we have all this apart from Sina, in the bottom line where our number of 45 million is a record high, and Sina's number is only 43 million. We are very happy.

John Bai - Credit Suisse

Yes that's very good, thanks.

Operator

Thank you. Does that conclude your question sir?

John Bai - Credit Suisse

Yes.

Operator

Thank you very much. The next question will be coming from Ming Cheng - Calyon Securities, please go ahead sir.

Ming Cheng - Calyon Securities

Thanks. Good evening, Lei Lei and Jay. Thanks for taking my question. My first question is on your WAP segment. Q4 declined by 3% quarter over quarter and you are citing a CDMA user decline for the reason. My question is, could you give us a breakdown of your WAP revenue from China Mobile and China Unicom? What's the trend are you seeing on the China Mobile side?

Jay Chang

I won't provide a specific breakdown for competitive reasons, but yes Unicom was down sequentially in the fourth quarter which drove the majority of overall WAP revenue decline. For China Mobile, it was up sequentially. Overall I think we see WAP as a key focus area that we're partnering very closely with China Mobile on in '06 that, hopefully as the CDMA user base stabilizes; as you know we're number 2 with Unicom. The other thing I think for Unicom is they're actually focusing more and more on their GSM network now. So I think for us, definitely the trend for China Mobile on the WAP side is they were very positive and optimistic for 2006.

Ming Cheng - Calyon Securities

So in your guidance for Q1, are you still seeing the increase in the WAP segment on China Mobile or as a whole?

Jay Chang

No I think we still see some weakness in Unicom CDMA which offset that. I think overall though, our wireless business will be slightly up quarter on quarter. Really, the guidance reflects weak seasonal online advertising more than anything.

Ming Cheng - Calyon Securities

My second question is on your music. Can you also give us a breakdown in terms of the revenue from the music from global music labels versus the local music labels? Also if you can give us a breakdown on the music from professional singers versus the Wanleba or the amateur singers?

Wang Lei Lei

I think it's a good question. From the start of our music strategy, the major music-related revenue was from the traditional music label songs, which is coming from the top five music labels of the world, like Sony. More recently, it is a very popular chance that many very popular stuff is coming from non-traditional labels, it's just coming from the Internet like one song, [inaudible] for 2005, his record just had 6 million transaction downloads per month.

We believe these days we are calculating about 50% songs are coming from the local music labels and the other 50% are coming from the top 5 international music label.

Ming Cheng - Calyon Securities

Okay so what about the Wanleba's contribution? Or other Internet singers like [Mice Love Rice] contribute? Do some of the local music labels also have those professional singers?

Wang Lei Lei

Yes Wanleba is TOM Online's most famous online music community, it can let people upload their own creative songs. Wanleba is a good complement to our existing music content which has [inaudible] music labels, and we hope there are other songs just like Mice Love Rice can come out from the Wanleba singers. But it has not happened yet.

Ming Cheng - Calyon Securities

Last question is, I wanted to have color on your 3G strategies, particularly the Skype application on the wireless front. If we look at Europe, Hutchison already started to build that into the cell phones to become the core 3G application. Now aside from the regulation, what's your strategy in China on that front?

Wang Lei Lei

I think we focus on the VoIP regulation. We believe the government didn't want to release the license until 2008. It's in the discussion period because some of the carriers are thinking VoIP services can kill their existing voice ARPU and some of the carriers are very positive for the Skype VoIP model but our first priority is developing the concurrent user base and the registered user base. An ideal case for the user to use the two phone services.

Ming Cheng - Calyon Securities

Okay great. Thank you very much.

Wang Lei Lei

Thank you.

Operator

Thank you. Does that conclude your question?

Ming Cheng - Calyon Securities

Yes, thanks.

Operator

Thank you very much. (Operator instructions) The next question will be coming from James Lee. Please go ahead sir.

James Lee

Mr. Wang, can you talk about your views of the mobile games in 2006? Maybe talk about your plans a little bit in terms of how many games you plan to launch?

Can you give some color on your early indication of your success in China? I believe you've launched a number of games on China Mobile platform already. Can you talk about that as well? Thanks.

Wang Lei Lei

Yes I think the mobile game in China is all based on the Java platform and it seems 2005 is incubation year because handset manufacturers just made many of the handsets which have Java functions. For this year, we believe the mobile games are ramping up quickly. Now we have a 20 people team and our business model, the mobile game from the different markets, and game production house. Now we have India Games which will just be a production house for TOM Online's strategy for mobile games.

And what was your next question?

James Lee

Maybe you can clarify that a little bit in terms of talking about how many games you have currently on China Mobile platform? How many more do you plan to introduce in 2006?

Wang Lei Lei

Now we have 20 mobile games on the China Mobile platform suitable for 120 models for the different brand of handsets.

James Lee

For 2006, any plans in terms of launching?

Wang Lei Lei

Our strategy is, in 2005 our ranking in terms of revenue for Java game business is ranking 25. Our target in 2006, we want to bring it into the top three position by the end of 2006.

James Lee

Okay that's certainly doable, given your size. Maybe Mr. Wang, you can talk about, there are some words about China Mobile, its lack of capacity on its game portal. Have you heard from them? Have they done anything to increase their capacity so when they have more subscribers who want to download a game and we have more games bringing onto the platform, that would not be an issue going forward?

Wang Lei Lei

China Mobile just selected [Asper], a company held by China Mobile to do their online gaming platform. They just transferred the platform which is based in Guangdong over to Beijing and it seems they focus on expanding their bandwidth and the servers and upgrade their billing system. Our strategy, mobile games are very different compared with fixed line, online game because the live peer rate is shorter than the online games. Mobile games life period is only three months and our strategy is, quantity is very important than quality for the mobile games.

James Lee

Now is the upgrade that you just mentioned, is that almost done or is still on an ongoing basis?

Wang Lei Lei

Ongoing basis.

James Lee

Okay, if I may squeeze one more question here. What do you think about handset alliances? This is a major way that you acquired customers. Do you think that's a viable way for you to continue to acquire customers going forward? Or do you think you need to find another avenue due to possibly pressure from China Mobile?

Wang Lei Lei

Yes many people are asking the same question. For '05 handset alliances is about 25% revenue contribution, as a percent of mobile wireless revenues for TOM Online. We believe China Mobile was very focused to have a direct relationship with a mobile handset manufacturer. But in China, it's very different compared with the other countries. China Mobile is not very big for the sales channel. For example, for '05 the total handsets sold in Mainland China is about 80 million but only 6 million handsets sold relate to the China Mobile sales channel.

So that means the handset manufacturer, they have their own sales infrastructure, the sales team, and they have more bargaining power to select those relationships with partners. So we believe the handset alliances will still be an important revenue contribution in '06 for TOM Online.

James Lee

Okay but in other words you look at -- if China Mobile increases purchase power, increased their channel, sell more handsets, that could provide a little pressure on you with the handset line.

Wang Lei Lei

Yes let me tell you the number for '06. Their budget will increase their self-sold handsets from 6 million to 12 million. But for the '06, the whole market handsets sold will reach 100 million. So compared with the whole market, it's still a small number. Also we have more communication with China Mobile's handset alliances department, which is called MIDC and are working closely with the carrier to embed our services into their sales channel handsets.

James Lee

If I could just put in one more question here, this is a more strategic question than anything else. In terms of convergence of the online internet and wireless internet in the future, obviously that's very important for you guys to be able to combine both, given your similar customer base on the internet and also on the wireless platform.

I just want to get your thinking; how do you plan to go about more effectively combining the two applications so users going forward, they can go on the PC and get the same application as they would on the handset? I just wanted to get a sense of what are you thinking there. How quickly can you get there and how you go about getting there.

Wang Lei Lei

Enhanced internet portals from the brand coverage and for user base and many of the community-driven services, because we believe our major competitors, Sina, Tencent, even include SoHo which have a powerful internet assets, they will take more advantage in the future of 3G platforms. So we must enhance our internet assets. This is the only one way.

James Lee

Okay, great. Thank you.

Wang Lei Lei

Thank you.

Operator

Thank you. Does that conclude your question sir?

James Lee

Yes.

Operator

Thank you very much. The next question will be coming from Mr. Wallace Cheung from Hong Kong. Please go ahead sir.

Wallace Cheung - Credit Suisse

Hi good evening. Two questions. First on the percentage revenue from non-channel operators. Do you actually expect TOM can increase that percentage further in 2006 as such will be one of the growth drivers? What I heard from Jay today was possibly you have roughly 15% to 20% from these three operators; this means like Unicom, China Telecom and Netcom in 2005. Could it be that you're increasing further?

Also the follow-up question will be saying that because there are rumors the China government may issue 3G licenses to China Telecom and Netcom even before China Mobile. Do you have a plan to work more closely with China Telecom and Netcom as well? Thank you.

Wang Lei Lei

We're very focused, we're very happy about Unicom's revenue growing faster than China Mobile because case studies, Unicom's user is half of the China Mobile's user base, but their data services revenue is only one-eighth of China Mobile's revenues. It's the same as other wireless revenues only less than 20% coming from Unicom. This does not match with their user composition.

Unicom seems to give up CDMA and the focus on GSM. Also the GSM data service and also the structuring of their data service management team. So we think they have a big opportunity to have the more revenue growth from Unicom.

For the fixed line carrier, we focus on developing a relationship to prepare for their future 3G platform. Another 3G license from the government, we believe that TD is the first standard for release because this is the revelation issue and the government strategy.

We believe no matter what about TD or WSAD, we are just in the position at the application level and we don't care at the back end, the technology platform. The telecoms are more positive with regard to the TD license, but it's another rumor from the government that after six months, which is the TD license for the carriers, they were released, another license for each carrier for WCDMA.

Wallace Cheung - Credit Suisse

Right, great. Thank you for the information. Another question is since I think TOM has built a pretty stable platform in terms of on the TV side and also on the handset alliances side, I think both platforms together actually account for roughly 45% total revenue on TOM Online in 2005. I just question, do we expect that could be further growth potential both organically and also a further increase on the partnership of both handset and TV stations that can drive TOM growth in 2006?

Wang Lei Lei

For '06 we will focus on developing the TV sales channels and believe the TV sales channels revenue contribution will come to 25% to 30% and if we add handset alliances it's nearly to 45% to 50%. It's since stabilized because the carrier changes their strategy, they give us more promotion resources and we work closely with the local carriers for the offline promotion, this is the big sales channel for us too.

Wallace Cheung - Credit Suisse

Okay, thank you.

Wang Lei Lei

Thank you.

Operator

Thank you very much sir. Does that conclude your question?

Wallace Cheung - Credit Suisse

Yes, thank you.

Operator

Thank you very much. The next question will be coming from Ming Cheng - Calyon Securities. Please go ahead.

Ming Cheng - Calyon Securities

Thank you. Jay I missed your guidance for the online ads. Did you say that it's going to decline 15% quarter over quarter because of seasonality?

Jay Chang

15% to 20%.

Ming Cheng - Calyon Securities

15% to 20%. Okay thank you very much.

Operator

Does that conclude your question sir?

Ming Cheng - Calyon Securities

Yes, thanks.

Operator

Thank you very much. (Operator instructions)

Jay Chang

If there's no further questions, thank you and we'll talk to you hopefully in Beijing or we'll talk to you next quarter. Thank you.

Operator

Thank you, and that concludes today's conference call. On behalf of TOM Online we would like to thank everyone for participating in today's conference. All lines may disconnect now and good day to you all. Thank you.

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