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Linktone Ltd. (NASDAQ:LTON)

Q2 2008 Earnings Call

August 29, 2008 9:00 pm ET

Executives

Serena Shi - Director, Investor Relations

Michael Li - Chief Executive Officer

Jimmy Lai - Chief Financial Officer

Analysts

Dick Wei - J.P. Morgan

Operator

Good evening, ladies and gentlemen, and thank you for standing by. Welcome to the Linktone second quarter 2008 results conference call. (Operator Instructions) I would now like to turn the conference over to Serena Shi with Investor Relations. Please go ahead, Madam.

Serena Shi

Thank you. Welcome to Linktone’s second quarter conference call. With me here today are Michael Li, Chief Executive Officer, and Jimmy Lai, Chief Financial Officer. Earlier today we announced our financial results for the second quarter ended June 30, 2008. Michael will begin today’s call with a review of this quarter and a discussion of Linktone’s strategy. Jimmy will review income statements and balance sheet for the second quarter. After that, we will open the call for 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 under 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 2008. Michael.

Michael Li

Thank you, Serena and thanks to everyone for joining us on the call today. This quarter, Linktone reports revenue of $19.1 million, and we took steps to improve our profitability going forward. We made the strategic decision to terminate our cooperation agreements with the Chinese Youth Internet Film and Television center with regard to Qinghai Satellite TV station. Excluding the one-time impairment charge of $6 million associated with the project, the company’s operating expenses would have been $6.4 million, which was down 12% from that of the previous quarter. This reduction in operating costs reflects our commitment to cost containment as we look to further streamline the company and return it to profitability, which is our top priority.

With the termination of these contracts, the company can now focus on its core wireless and fixed line value-added business and also leverage the resources of MNC to explore synergistic investment opportunities for future growth.

While we realize we still have much work to do, we are confident the steps we are taking will help the company to return to profitability and position the company for long-term growth.

Now I would like to turn the call to Jimmy.

Jimmy Lai

Thank you, Michael. Linktone’s second quarter gross revenue was $19.1 million, compared to $20.5 million for the first quarter of 2008 and $11.7 million in the second quarter of 2007. SMS revenue was $4 million for the second quarter, compared with $5.4 million for the first quarter. The reduction of the SMS revenue was due to a restriction on the service fee that the company can charge to its customers per usage as a result of the implementation of a performance ranking policy by one of the telecom operators, effective April 2008. Under this policy, service providers are ranked quarterly according to certain performance criteria that determine the maximum service fee they may charge on each usage. The company’s initial ranking resulted in a reduced fee that Linktone can charge to its customer during the quarter. The customers ranking for the third quarter of 2008 has not been finalized yet.

Revenue from our 2.5G products, namely MMS, WAP, and Java, totaled $2.9 million in the second quarter, compared to $1.9 million for the first quarter. Data related service revenue for the second quarter totaled $6.9 million, representing 36% of total revenue compared to $7.3 million, or 36% of the first quarter 2008.

Audio related revenue, IVR and CRBT, were $7 million versus $8.3 million for the prior quarter. Advertising service revenue increased to $4.6 million this quarter, versus $4 million for the first quarter of 2008. The increase in advertising service revenue was primarily due to a more aggressive pricing strategy on Qinghai Satellite TV and ramping up of the company’s advertising arrangement with Tianjin Satellite TV, which more than offset the adverse impact of the Sichuan earthquake.

Linktone’s gross margin for the second quarter of 2008 was 9% of net revenue, or gross revenue minus business tax, compared to 17% for the first quarter of 2008 and 39% for the second quarter of 2007. The sequential decrease in gross margin was due to two reasons: one is that lower margin from our telecom value-added services as a result of the previously mentioned restrictions placed on service fees charged to customers, and the other one is the higher costs arising from additional revenue sharing arrangements with respect to cooperation projects with mobile handset manufacturers to promote the company’s products to its customers.

Operating loss was 58% of net revenues, compared with operating loss of 20% for the first quarter of 2008 and operating margin of 32% in the second quarter of 2007. The sequential increase in operating loss was primarily attributable to an asset impairment charge of $6 million during the quarter.

Operating expenses totaled $12.4 million, compared with $7.3 million in the first quarter of 2008 and $8 million for the second quarter of 2007. Excluding the one-time impairment charge of $6 million, operating expenses would have been $6.4 million, which were 12% lower than those of the first quarter of 2008. The sequential decrease in operating expenses excluding the impairment charge was primarily attributable to lower selling and marketing expenses and other G&A expenses.

Selling and marketing expenses were $3.2 million, compared with $3.8 million for the first quarter of 2008 and $3.9 million for the second quarter of 2007. The sequential decrease was due to a decrease in traditional media advertising as the company increased its focus on cooperation projects with mobile handset manufacturers, as mentioned above, in the second quarter. The expenses related to such projects were included in the cost of sales.

Product development expenses were $0.7 million, compared with $0.8 million for the first quarter of 2008 and $1.5 million for the second quarter of 2007.

Other G&A expenses were $2.5 million compared with $2.7 million for the first quarter of 2008 and $2.6 million for the second quarter of 2007.

GAAP net loss was $10.6 million, or $0.26 per diluted ADS shares, compared with GAAP net loss of $4.2 million, or $0.18 per diluted ADS shares for the first quarter of 2008 and GAAP net loss of $3.2 million, or $0.13 per diluted ADS share for the second quarter of 2007.

Now I would like to go to the balance sheet and review a few balance sheet related items.

Cash and cash equivalents, as well as short-term investments available for sale, totaled $105.3 million, compared with $39.7 million for the first quarter of 2008. The increase in cash and cash equivalents was primarily due to the strategic investment of $68.4 million received from MNC in April 2008. Net cash outflow from operations totaled $2.6 million and was mainly attributable to the operating loss from the company’s advertising business.

Days sales outstanding, the average length of time required for the company to receive the payments for sales delivered, were 69 days at the end of the second quarter 2008, compared with 58 days at the end of first quarter. The sequential increase was due to lengthening collection period from the company’s telecom value-added business.

Finally, our business outlook for the third quarter 2008: Linktone expects gross revenue to be approximately $18 million to $19.5 million, with WVAS and game revenues to be between $14 million to $15 million and advertising revenues to be between $4 million to $4.5 million.

With that, I will now turn the call back to Michael for some closing remarks. Michael.

Michael Li

Thanks, Jimmy. As we’ve said, the top priority of Linktone’s management is to bring the company back to profitability. We are aiming to achieve this goal before the end of this year. At this point, we would be happy to answer any questions you may have. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dick Wei with J.P. Morgan. Go ahead, please.

Dick Wei - J.P. Morgan

Good morning, Michael and Jimmy. Just a question on regarding the strategy of the company. I guess with the termination of the contract with Qinghai Satellite TV, are you still going to continue with the Tianjin Satellite TV? And how should we think about the advertising revenue going forward? Should it reduce down to zero by the end of the year or is it -- how should we think about that?

Jimmy Lai

The Qinghai Satellite TV is very much different than the Tianjin project. The structure, the economic arrangement, and the project itself is very much different. The reason we terminated Qinghai is after the MNC investment, we take a very close look into the near-term and mid-term profitability of this project and we determined that it’s difficult to break even, even in mid-term levels, so we make the conscious decision to terminate this contract.

As to the Tianjin Satellite TV, currently we are still very optimistic about this project and we will continue this sales project. This doesn’t mean that the end of our cross-media strategy with the termination of the Qinghai Satellite TV. If we see one that makes economic sense and fit into our strategy, we’ll continue to do it.

Does that answer your question?

Dick Wei - J.P. Morgan

Yes. If you can also remind us what kind of business model that you have with Tianjin Satellite TV -- is it mainly more just as a traditional agency type of business or is it mainly wireless related type of advertising on the Tianjin TV as well, that would be helpful. Thanks.

Jimmy Lai

As we announced previously in our announcement, the Tianjin Satellite TV project is a purely advertising arrangement where we have the so-called non-[four-eight], non-infomercial advertising, exclusive advertising rights from Tianjin Satellite TV, so that is the arrangement we have with Tianjin Satellite TV.

Dick Wei - J.P. Morgan

Okay. In this sense, are you going to -- are you thinking to go after more of the other satellite TV stations as well going forward?

Jimmy Lai

We will look into that and if we see a project that fits into the economic criteria that we set internally and then we will seriously consider it. But like I said, the current company’s management focus is to return the company back to profitability, so any project we undertake has to meet this criteria.

Dick Wei - J.P. Morgan

Okay. I guess return on profitability could make that -- I guess put more focus on the wireless business, as you mentioned in the past. I believe the China Mobile now has different tiering and I think for the SMS side, maybe Linktone is not among the top tier of service providers. Just wondering, any particular products we try to focus more to drive up the ranking at China Mobile in terms of WAP or MMS or like SMS, or I mean you put more focus on that or have you been focusing more on the advertising side to drive profitability? I guess just more of a general strategy question on the company.

Michael Li

I think in the next few quarters that the revenue of Linktone still consists of two parts -- one is from the WVAS and another part is still coming from the advertising from the traditional media, like Jimmy Lai mentioned that we still pursue the cross-media strategies. But in terms of the WVAS revenues that I think that without the -- with the [inaudible] of the QTV, actually we can focus more on wireless and also Tianjin and other potential opportunities with other traditional media, actually that we projected that wireless already bottom up for Q2 at Linktone, so that with Q3 projections, you can see that it is already stabilized and also get back to more profitable business.

So going forward, for wireless that beside the previous product and service we have been doing for the past few years, we aggressively look for the new opportunities for the 3G related technologies and services. But 3G revenues will come out significantly in the next -- I don’t think in the short-term but most of the revenue from the previous application related.

Dick Wei - J.P. Morgan

Okay, great. Thanks a lot for answering my questions.

Operator

(Operator Instructions) We have no further audio questions. I would like to turn the conference back over to management for any closing statements.

Serena Shi

Thank you, everyone, for joining us. This concludes today’s teleconference call for the second quarter 2008 financial results. Please contact us should you have any additional questions. Thanks again for joining us today. Bye.

Michael Li

Thank you.

Jimmy Lai

Thank you.

Operator

Ladies and gentlemen, this concludes the Linktone second quarter 2008 results conference call. If you’d like to listen to a replay of today’s conference, please dial 800-405-2236, or 303-590-3000, with the passcode 11118495. ACT would like to thank you for your participation and you may now disconnect.

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