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Focus Media Holding Limited (NASDAQ:FMCN)

F3Q07 Earnings Call

November 19, 2007 8:00 pm ET

Executives

Jie Chen - Investor Relations

Jason N. Jiang - Chairman of the Board, Chief Executive Officer

Daniel M. Wu - Chief Financial Officer

Analysts

James Mitchell - Goldman Sachs

Jason Brueschke - Citigroup

Richard Ji - Morgan Stanley

Eddie Leung - Merrill Lynch

C. Ming Zhao - Susquehanna

Jackie Chan - CIBC World Markets

Aaron Kessler - Piper Jaffray

Marisa Ho - Credit Suisse

Presentation

Operator


Good day, ladies and gentlemen, and welcome to the third quarter 2007 Focus Media Holdings Limited earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host, Ms. Jie Chen, Investor Relations Manager. Please proceed, Madam.

Jie Chen

Thank you. Welcome to Focus Media's third quarter 2007 earnings conference call. Today, our management will discuss the company’s financial results for the third quarter of 2007 and business outlook for the fourth quarter 2007. With me here are Jason Jiang, Chairman of the Board and Chief Executive Officer; and Daniel Wu, Chief Financial Officer. After Daniel updates you on our third quarter 2007 operational and financial performance, we will open the call for questions.

This call is also broadcast through the Internet and available through our investor relations website, ir.focusmedia.cn.

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. The statements include but are not limited to statements regarding Focus Media's business objectives and plans, the expectations of development of our networks and our outlook for the fourth quarter 2007, for example. You can also identify forward-looking statements by terms such as "will," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar statements. The accuracy of those statements may be affected by a number of risks and uncertainties that could cause our actual results to differ materially from those projected or anticipated.

These risks and uncertainties include but are not limited to our limited operating history for the current operations and short history of the audio-visual advertising sector, which may make it difficult for you to evaluate the viability and prospects of our business, the integration of acquired businesses, competition from present and future competitors in China’s growing advertising market, and other risks outlined in our filings with the SEC, including our registration statement on Form F-1.

We do not undertake any obligation to update this forward-looking information except as required under applicable law. Now, I will turn the call over to our CFO, Daniel Wu, for a summary of the third quarter 2007 financial results.

Daniel M. Wu

Thank you, Jie. I am pleased to report to you another record quarterly results in the third quarter of 2007. Our total revenue, excluding sales tax, reached $151.4 million, increasing 149.6% from the same period last year and 33.6% sequentially. Our third quarter revenues include $94.7 million from our digital out-of-home advertising business, $14 million from our Focus Media wireless advertising business, and $42.5 million from our Internet advertising business.

First, let me review in detail the results of our digital out-of-home advertising business. Total advertising revenue from our digital out-of-home advertising reached $94.7 million in the third quarter of 2007, up 66.1% as compared to $57 million in the same period in 2006, and also increased 23.3% sequentially.

Within our digital out-of-home advertising business, the revenue from our commercial location network in the third quarter was $64.6 million, up 67.7% year over year.

The revenue from our in-store network was $71 million, as we continue to compete aggressively with our competitors in the in-store business.

The revenue from our poster frame network in the third quarter was $23.1 million, up over 100% year over year as the occupancy rate grew sequentially after taking into consideration the increase in capacity due to the digital upgrade. So the business is growing and continues to gain momentum.

The commercial location network, in-store network, and poster frame network contributed 68.2%, 7.5%, and 24.3% of the total digital out-of-home advertising revenue respectively in the third quarter of 2007.

During the third quarter of 2007, Focus Media wireless business generated revenue of $14 million, up 298.9% from $3.5 million in the third quarter of 2006. Advertising revenue for our Internet business, Internet advertising business, was $42.5 million in the third quarter of 2007, up 68.5% sequentially.

Digital marketing service accounted for 94% of the total Internet advertising revenue. Rich media, pay-for-performance, and technology solutions accounted for the remaining 6%.

Gross profit for the third quarter of 2007 was $77.1 million, representing an increase of 99.9% compared to $38.6 million for the same period a year ago.

In the third quarter of 2007, gross margin for our digital out-of-home business was 62.7%. Within the digital out-of-home business, the commercial location network gross margin was 64.7%, in-store network gross margin was 17.7%, and poster frame network gross margin was 71.1%.

Commercial location gross margin was negatively impacted by the acquisition of leading outdoor billboard operator in China in the second quarter of 2007, which operates over 200 highly attractive outdoor billboard locations in major commercial centers in China. Excluding the non-digital outdoor billboard business, commercial location gross margin would have been 74.6%. We plan to upgrade some of the sites to digital LED billboards upon expiration of the current contracts with advertisers.

This acquisition provides Focus Media with a stronger strategic position for the growth of our digital out-of-home business in the future.

The gross margin for our mobile advertising business was 56.2% in the third quarter of 2007. The gross margin for our Internet advertising business was 23% in the third quarter, lower than the previous quarter due to several small acquisitions in this quarter to strengthen the market leadership of Allyes. We expect the gross margin of our Internet advertising business to trend up going forward as we leverage Allyes’ strong technology platform to improve the business operation of these acquired entities.

Blended gross margin for the company for the third quarter was 50.9%, as compared to 54.6% in the second quarter of 2007, due to the contribution of the lower margin Internet advertising business and in-store advertising business.

Third quarter operating expense totaled $30 million, including $1.1 million in acquired intangible asset amortization resulting from historical acquisitions and non-cash share-based compensation expense of $4.4 million. As a result, operating margin in the third quarter of 2007 was 31.1%, excluding non-cash share-based compensation expense and acquired intangible amortization expense, operating margin on a non-GAAP basis was $36.4 million in the third quarter.

Operating expenses in the third quarter of 2007 also includes a one-time expense of approximately $2.1 million relating to the recent audit committee inquiry during the summer.

GAAP net income for the third quarter of 2007 was $46.6 million, or $0.37 per fully diluted ADS, up 72% from $27 million for the same period a year ago. Non-GAAP net income excluding non-cash share-based compensation expense and amortization of acquired intangible assets in the third quarter of 2007 was $54.6 million, or $0.43 per fully diluted ADS.

Now I would like to provide Focus Media's business outlook for the fourth quarter of 2007. Please note the following outlook statements are based on our current expectations. These statements are forward-looking and actual results may differ materially.

We expect total revenue for the fourth quarter of 2007 to be between $160 million and $170 million; non-GAAP fully diluted earnings per ADS to be between $0.48 and $0.50.

Thanks very much. Now we’ll open the call for your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of James Mitchell with Goldman Sachs. Please proceed.

James Mitchell - Goldman Sachs

Thank you very much for taking my question this morning. I had a question just about the billboard acquisition you made during the quarter. I think you disclosed the gross margin including and excluding billboard, which implies that billboard had maybe $5 million in cost. I wanted to check first whether the billboard business during the quarter was profitable and secondly, whether the billboard business was part of the reason why you had increases in sales and marketing costs and increases in receivables during the quarter versus the previous quarter. Thank you.

Daniel M. Wu

Let me answer that question. First of all, the billboard business we acquired is a profitable business and actually, the acquisition was also based on similar patterns of Focus Media’s previous acquisitions based on multiple year earn-out agreements. So they have to hit performance targets in order to get paid in multiple installments going forward.

And their gross margin was roughly about 25%, which is normal in the outdoor billboard industry in China. And the reason we acquired them, as we said in the press release, we really think the sites currently they operate are very attractive and potentially some important sites in major commercial centers can be upgraded to digital LED, which we believe is a much higher margin business moving forward. So we’ll be looking to those upgrades in the future when the advertising contract expires.

The AR increase actually in our business is normal. If you look at the DSOs for this quarter, it is roughly about -- it is higher than roughly about 70 days in the previous quarter but within expectations of 70 to 90 days on average we estimate for Focus Media's business.

So the overall AR increase was not relating to this billboard acquisition but it’s pretty much how the business operates going forward.

So James, hopefully this answers some of your questions.

James Mitchell - Goldman Sachs

Sure. I was also just asking with the sales and marketing, whether the increase there was slightly due to the billboard acquisition or whether it was fully organic.

Daniel M. Wu

It’s normally -- in the billboard business, we also pay sales and marketing and in our industry, the sales and marketing average is roughly about 10% to 15%. It really depends on different business and different situations as we explained earlier. For example, the commercial location network when in the city we enter first, which we -- where the revenue base is very small, we typically offer higher sales and marketing commissions; in cities which are more mature, we offer lower.

So it’s a blended base of that. The outdoor billboard business is nothing unusual out of that norm, so if you look at an overall sales and marketing expense of Focus Media this quarter, roughly about 12%, 13%. So it’s on average how we expect going forward.

James Mitchell - Goldman Sachs

Okay. I guess the billboard business is sort of a land grab business, like some of your other out-of-home businesses. Anyway, thank you. I’ll get back in the queue.

Operator

Your next question comes from the line of Jason Brueschke with Citigroup. Please proceed.

Jason Brueschke - Citigroup

Thank you. Good morning, everyone. I have two questions, please. The first one is more of a general question involving gross margins. As the media market in China has really been expanding a lot in the last five years, and obviously it’s very fragmented, and it’s apparent that Focus has adopted a strategy of acting as a consolidator, at least in selective parts of this market.

My question within this context is how should we be thinking of modeling the gross margins going forward? Since on the one hand, most of your targets have lower gross margins that [inaudible] before you acquire them, and notwithstanding the fact that you have an excellent track record of quickly growing those gross margins after the acquisitions, the timing of these deals certainly makes modeling the gross margins more choppy.

So maybe for the next three or four quarters, can you give us some general color on what we should be expecting on that front? And then I have a follow-up question. Thanks.

Daniel M. Wu

Sure. Thanks, Jason. Let me answer this question first and I think overall, Jason can help me relating to the strategic position for Focus Media acquisitions going forward, relating to gross margin.

First of all, if you look at Focus Media's gross margin, how we look at it is we actually look at each media individually. So if you look at the gross margin for commercial location business itself, without the impact of the acquisition of digital out-of-home, digital billboard business, our gross margin is pretty healthy. It’s close to our target of 75%.

So the acquisition of the outdoor billboard business, as we discussed a little bit earlier, allows us to position ourselves to be able to upgrade those to digital sites once the contract with advertisers expires, because otherwise if we don’t get into those business, basically we have to compete with existing billboard location operators for those sites. It makes that business much more difficult and potentially costlier.

So the acquisition itself for us allows us first of all to expand our presence, and second to get access to those sites through -- from our point of view, it’s a more effective [means].

If you look at the in-store business, right now we do have a lot of competition so the business as we talked about in the previous quarter, we do expect that business to be under pressure as long as the competitive situation does not resolve itself, but it’s still a small percentage of the overall business.

The gross margin is still 17% and that means basically we’re still making break-even or make a slightly small amount of money in that business.

The poster frame business is pretty healthy, how we look at it. Although we are already taking depreciation expense of the digital upgrade, the gross margin still stays about 70%. We expect long-term gross margin to be 75%.

The mobile advertising business gross margin between 50% to 60% and we expect that to be within range until the 3G upgrade of network has been implemented by the mobile operators.

Internet advertising is actually the lower margin business that we entered recently. If you look at the business we got, we have acquired Allyes and a few others, basically allows Focus Media to strategically position ourselves for the growth of Internet advertising business.

We are currently in the process of aggregating traffic and establish a dominant presence in the Internet advertising service business. Going forward with most of the acquisition already being completed, what we expect to do is using our technology strength to do more targeted advertising going forward.

So in the long-term, of course, Internet advertising business we expect, based on the current model, can move towards 35%, 40% in the long-term, of course potentially be better. It really depends on how the pay-for-performance search business in China is going to take off, but also if you look at -- if you purely focus on gross margin, if we report gross margin on a net basis for that particular business, of course the revenue base will be smaller but net margin will be higher, as some of the U.S. comparable companies do in this particular business.

So Internet advertising is a business we are investing in right now but we really don’t think that that margin at this time is a good representation of the long-term gross margin of our Internet advertising business.

Just give me one moment. I’ll have Jason answer in terms of the strategic position going forward, in terms of how we look at our margin business.

Jason N. Jiang (Translation)

In terms of acquisition strategy going forward, if you look at Internet, we have done all the major acquisitions for the leading provider of Internet marketing services in China, so going forward the shift of focus and more focus on technology. So if there are good technology for Internet advertising which will help us to improve our business operation of our Internet advertising business, we potentially will consider acquisitions but if you think about those acquisitions, they are relatively much smaller in size. It’s basically if they are a good, emerging technology which we believe will be helpful to improve the operation of the business we already have, and also do keep in mind Allyes is the leading provider of technology solutions for Internet advertising in China, given their large market share.

The second area is regarding the outdoor location, out-of-home locations. If you think about what we look at those, in China, the high traffic locations for out-of-home advertising, there is a scarcity of resources, so it’s a very limited number of where you really can do it, where the value really can demonstrate itself and also be appreciated by the advertisers.

So from a Focus Media point of view, given we are already the largest digital out-of-home media provider in China, if there are opportunities for us to get into some of those highly attractive but limited availability of highly attractive locations through acquisition, we will be considering that because we believe in the long-term, as the China advertising market continues to grow, the resource of locations is always limited, as the best locations will actually attract the best advertisers which offer the highest return for the advertising business.

So the way we look at it is although we have done this acquisition in the second quarter, which expands our presence in the outdoor billboard business, once the advertising contracts with those advertisers for the existing billboards expires, we are looking to upgrade some of them to digital which we believe in the long-term the margin will be better. But also in the future, if there are good opportunities for us to do this, to get a hold of some additional highly attractive locations, we’ll consider that as well.

Jason, hopefully this addresses some of your questions.

Jason Brueschke - Citigroup

Very helpful. And my follow-up question, or my second question actually has to do with the announcement in the press release that you would consider possibly listing separately the wireless advertising division. We haven’t really gotten a lot on this business the previous three quarters as the business has been growing around 300% year over year. It’s kind of a sleeper business within the overall portfolio.

In light of this announcement that you would consider possibly listing it, could you maybe update us and give us some color on the state of the mobile handset advertising market in China, what your competitive position is? Or maybe just a few comments on how this business as you see it may be differing from the wireless value-added services business of say a KongZhong or Hurray!, which most people might be more familiar with? Thank you.

Daniel M. Wu

Sure. Thanks, Jason. I’ll translate for Jason.

Jason N. Jiang (Translation)

First of all, regarding the wireless advertising business which we operate, the biggest difference of versus some of the traditional wireless value-added service providers KongZhong and Linktone, is that we do not receive payment from the consumers. We actually get paid by the advertisers. So basically, it’s not we are being paid by the consumers through China Mobile. It’s not like China Mobile collects the fees and then pays us for the service the consumer purchase.

But the relationship in our business is the advertiser pays us, then we pay China Mobile operators. So the consumer does not pay, so the business model is very different.

If you look at the competitive landscape of this business based on industry research, we are roughly about 50% of the market and the market today is roughly about $100 million in China. The remaining market is actually competing by a lot of smaller competitors, much smaller competitors versus us, so if you look at this competitive landscape, the competitive advantage of Focus Media wireless advertising business is because we control a database -- we actually have a database of more than 200 million mobile users in China, which allows us to do better targeting when we deliver ads to those mobile users.

Targeting is extremely important for mobile advertising going forward. Let me give you a couple of examples. First of all, let’s say right now what we are doing is we can provide some WAP advertising business, people access WAP, and once they get on the WAP, the advertising they see is based on an address, and this digital ID is actually stored in our database, which identifies their traffic patterns -- very similar to the Internet advertising business.

Also, for example, we work with MSN not only on the Internet side, which Allyes worked with them, we also represent them on the wireless business, Wireless MSN, so we actually deliver ads through one of the largest wireless information platforms and that allows us to target a very attractive profile of consumers in China.

And also, we are also experimenting some location-based business with local regional mobile operators. For example, in the recent auto show in Guangzhou, which is one of the largest auto shows in China, the consumers walking through this auto show, they will receive three different advertisements. This is based on the location where they are at, and so the advertising of course is relating to auto and it’s targeting a very attractive potential group of consumers in China.

So all those ways of doing advertising is very similar to the other part of the Focus Media business. If you look at the Focus Media digital out-of-home, look at Focus Media Internet advertising, it’s all about providing highly targeted advertising for our advertising clients.

For this market, we believe going forward, given the catalyst of 3G upgrade of China Mobile operators, we believe the market will grow going forward at potentially up to 100% on a year-over-year. It’s a very small market right now; it’s only about $100 million but it’s a huge potential, taking into consideration that there are 500 million mobile users in China versus only about 160 million Internet users in China.

So this advertising media based on our understanding of the market will grow very, very fast going forward. That’s why we are considering a possible cut-out of this business, have a separate listing in different exchange, so the business actually can be better appreciated by the investors who are interested in investing in this business, and of course it allows us to continue to operate this business in this very fast growing business, through a potential consolidation going forward, as well if there is such opportunity exists for this business.

So this sort of was a long answer to your short question, Jason.

Jason Brueschke - Citigroup

It’s very, very helpful. I appreciate that.

Operator

Your next question comes from the line of Richard Ji with Morgan Stanley. Please proceed.

Richard Ji - Morgan Stanley

Good quarter, and I have two questions, starting with online advertising. Obviously only two quarters after inception, online advertising already become the number two revenue driver for your company. And on that note, I’m just wondering about any revenue contribution from your recent acquisition. In other words, what is the organic growth for your Allyes business?

And a follow-up question is again regarding the synergy between your online business and Allyes business, and your other business -- how much of the sales come from the direct sales from Allyes and how much of that comes from the cross-selling by your sales force in your other business?

Daniel M. Wu

I’ll answer the first question and then ask Jason to answer the second. Let me answer the first question. The Allyes business actually quarter over quarter grew roughly slightly over 20%, so that business is also growing very healthy and we believe fourth quarter will be another very good quarter for Internet advertising based on the historical seasonality of this business.

So this business is growing very healthy. The additional acquisition we talked about in the press release of some of the smaller acquisitions allows us to establish our market position in terms of attractive verticals, such as auto, real estate, in-game advertising. Those are more like -- these companies are not in any way similar to the scale of Allyes and have as strong a technology base as Allyes, but those advertisers, those Internet marketing service companies already have their presence in a particular vertical industry. We believe those industries will be helpful to consolidate Allyes business going forward, so that’s why we make those smaller acquisitions.

I’ll ask Jason to help answer in terms of cross-selling versus the sales by Internet advertising staff.

Jason N. Jiang (Translation)

I think if you look at the Allyes business, when we acquired them they principally operate in Beijing, Shanghai, Guangzhou and today, given the vast amount of advertising sales coverage of Focus Media, we have already started a joint sales effort with the Allyes sales team in six major cities in China. But do keep in mind, the principal sales, the sales still covered by the Allyes sales marketing team, our sales marketing people is basically to help them to access to clients of Focus Media and help them to successfully converting clients or land clients through their competitiveness, competitive Internet advertising business.

So it’s more like they are still driving the sales marketing effort. We are helping them to get access to clients and converting clients.

But this effort has actually demonstrated tremendous results, because you can see Allyes advertising clients this year has grown very, very fast versus historical levels. If you think about the long-term Focus Media strategy for the Internet advertising business, we are not a content based Internet advertising business. What we try to do is we try to drive a pay-by-performance based Internet advertising business.

The most important thing for pay-by-performance advertising business, which in the future we believe that’s the way the future Internet advertising will be, because it’s a highly targeted feature of pay-by-performance because it delivers actual results for the advertisers.

We believe the most important key element for success in the pay-by-performance is to be able to aggregate a large amount of traffic, because if you do not have the traffic, then there is very limited reach for pay-by-performance and that’s not going to be very attractive for an advertising perspective.

So going forward, Allyes will continue to focus not necessarily through acquisition but acquisition is one of the possibilities, but we have done all the large acquisitions. But we also look at trying to work with the web publishers to come up with plans or partnerships or ways to aggregate a large amount of traffic for Allyes technology platform to service.

So by doing that, we believe that will give us a very, very comfortable platform to grow our pay-by-performance business.

Today, the sales marketing effort still increasingly driven by the Allyes sales team because they have much more experience and knowledge in this Internet advertising business. But next year, starting from 2008, given the growth of our Internet advertising business, given the [inaudible] of our technology deployment by Allyes, we are looking to actually start doing some of the standard based out into the advertising solution. So if there are standard-based products which we will be able to deploy next year, then it’s possible we’ll leverage the near 2,000 sales marketing people within Focus Media’s other business to help Allyes to sell those products to their clients. But still, this is the plan in the future.

Richard Ji - Morgan Stanley

Thank you, Daniel. My second question is regarding your poster frame network. Obviously it shows a very robust growth and I’m just wondering how much of the revenue comes from your digital frame 2.0 and obviously the frame 2.0 will significantly increase your advertising inventory for the poster frame network. On the other hand, what is the pricing difference between frame 1.0 and frame 2.0?

Daniel M. Wu

Sure, let me answer this question. Actually, the way it is actually sold, if you think about our digital upgrade process, there is really no different price for digital and the traditional, except if an advertiser buys digital, they actually only get 30 seconds out of the one-and-a-half minute cycle.

So if you think about let’s say any advertiser, Volkswagen, if they come into Shanghai and want to do advertising, we may have 20,000, 30,000 different frames in Shanghai. They will provide basically a demographic profile of their preferred location. They do not usually advertise in all the 30,000 locations. They would say I want this type of income level, it depends on the model of the car, I want to reach these areas, locations, or I have a preference to a certain type of people, a certain type of residence profile, like close to a college or those types of things.

Once they specific that profile, we go through our database, come up with maybe let’s say 5,000 locations where we think it’s suitable for their advertising and once they buy 5,000 locations, out of those 5,000 locations maybe 10% of them have actually already upgraded to digital.

So they actually don’t pay a separate price for digital. They still buy those 5,000 locations but with the knowledge of those digital sites potentially they have to share with two additional advertisers, they only get 30 seconds out of a one-and-a-half minute cycle. So there’s really no different price strategy for the digital frame -- it’s just a continued upgrade of our network.

But of course, as the digital rollout is getting larger and larger, the network itself actually can be sold separately, so there may be advertisers -- there are advertisers coming to us and saying I only want to buy digital because my advertising is only we believe it’s not suitable for a traditional advertising, traditional paper-based advertising. Our advertising, we want to have this digital image. In those situations, we actually do sell but of course the price will be the same as we published on the website, but of course different discount levels are negotiated -- it depends on the actual situation.

So this is how we sell the digital versus the traditional for the poster frame network. If you look at what we have reported, the digital frame basically accounts for three kinds of capacity, so basically if you have 100 traditional and you have 10 digital, then your capacity becomes 100 plus 10 times three, so it becomes 130. So even with an increased capacity in our business, our utilization rate continued to go up sequentially versus last quarter. So it basically shows the digital upgrade actually has a tremendous attraction to a lot of the advertisers and we really don’t see those additionally created inventory left open because there are people taking up those inventories because of attractiveness of the digital upgrade.

Richard, does that answer your question?

Richard Ji - Morgan Stanley

Yes, very helpful. Thank you, Daniel.

Operator

Your next question comes from the line of Eddie Leung with Merrill Lynch. Please proceed.

Eddie Leung - Merrill Lynch

Good morning, Jason and Daniel. Good quarter. Questions regarding your core office buildings network; could you give us an update on the progress you have made in providing those customized solutions to advertisers in terms of geographical segmentation? And what kind of lessons have you learned from testing these new offerings in the past quarter?

Daniel M. Wu

Let me translate for Jason.

Jason N. Jiang (Translation)

A couple of examples we can give you, Eddie, is as follows; if you think about let’s say if there’s a real estate advertiser, he has a new residential project in Shanghai, want to advertise in Shanghai, what we can actually allow him to advertise is he can actually only show the advertising in the area near where their construction project is. So let’s say this residential project is in Pudong -- Shanghai is Pudong and Pushi -- so if they are in Pudong, then he doesn’t have to pay for those buildings in Pushi to show the advertising. He only needs to pay for those buildings in Pudong where we have networks to show his particular residential project.

This particular coverage is maybe only about 20% of all the buildings Focus Media has in Shanghai but typically the advertiser would have to pay roughly maybe 40% versus the price others would have to pay for the entire Shanghai if he showed advertising in all those buildings.

So for us, it’s actually a better cost benefit on a per building basis and allows us to achieve higher margin, but for him actually, his advertising is much more targeted because he doesn’t have to pay for those eyeballs in Pushi which potential be is the likelihood of becoming his customer is less.

So also, another example, let’s say Mercedes-Benz. If Mercedes-Benz only want to advertise in the top 100 buildings in major cities in China, so he believes all his customers are in those top 100 locations in major cities in China, so of course we can charge him on average relative to -- otherwise he would pay for the entire city, we’ll charge him a lower rate but because his advertising is only showing in those 100 buildings, the top buildings in the city, we actually are able to achieve better revenue on a per building basis for our network.

So this type of customer advertising is actually gaining more and more traction because first of all, it’s very unique. You cannot do it with newspaper. You cannot do it with TV, so it’s a highly targeted feature and allows Focus Media's media to become more competitive and be more customized for our advertising clients, and actually also allow us to improve our revenue and margin of our commercial location business going forward.

So this idea is very similar to all the other businesses Focus Media operates, if you think about we talked about pay-for-performance for Internet advertising, it’s the same thing. It’s about targeting. If you think about the digital upgrade of our frame 2.0, it’s the same thing. It allows us to do much better targeting within the residential sector.

These are the things that are consistent with Focus Media’s strategy of providing highly targeted advertising solutions for advertisers, so that’s how we look at this particularly business.

Eddie Leung - Merrill Lynch

Thank you. A very quick follow-up; are these solutions available to most clients or just a selected group of advertisers?

Jason N. Jiang (Translation)

Today it’s still a small percentage of revenue but if you think about not only do we need to provide a tailored solution for the advertisers based on location profile of their requirements, but also let’s say if this advertiser only advertises in Pudong, we need to actually find an advertiser who will only advertiser in Pushi to balance out the utilization of the network, to maximizing the evaluation of the network.

So today, it’s still early stage but as more and more advertisers understand the attractiveness of this particular solution and as our sales and marketing people more and more actually understand the new sales approach for these type of solutions for a group of advertisers, we believe these types of sales marketing will actually increase in the overall revenues, allow us to increase the margin of our commercial location network.

Eddie Leung - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of C. Ming Zhao with SIG. Please proceed.

C. Ming Zhao - Susquehanna

Thank you for taking my questions. Two questions; one is for Jason, one is for Daniel.

Jason -- (translation not available). My first question is what cities are those billboards in, how many of them are from Beijing and Shanghai, and when will those existing advertising contracts expire?

Jason N. Jiang (Translation)

For this company, the outdoor billboard company we acquired in Q2 of 2007, the majority of their sites are actually located in Beijing, Guangzhou, Shanghai. Of course, they also have locations in major second tier cities, like Chengdu, [Zhuhai], those locations where -- at very highly trafficked commercial locations in those particular cities.

Typical advertising contracts as in the China outdoor billboard business is roughly about one year or two years, and of course some of the advertising contracts were already under execution when we acquired the business, so they may have six months left. So once those current advertising contracts expire, we look at selectively upgrading those sites to digital if the opportunity presents to us.

So does this answer your question?

C. Ming Zhao - Susquehanna

Okay, that’s good. Another question for Daniel here; if I look at the cash flow statement, and try to understand this item, which is the prepayment to acquired subsidiaries. It’s about $25 million for the third quarter of ’07. My question is if I look at this item, this should be the amount that you -- sort of a deposit payment, but does that mean the acquisitions have been included in the third quarter’s revenue contribution?

Daniel M. Wu

Yes, first of all, the short question is the acquisition has been concluded but do keep in mind, a lot of the acquisitions we’ve actually done on a multiple year earn-out basis, so that’s why it’s showing as a deposit because it really depends on how they achieve their committed net income target, so that’s how they get paid.

C. Ming Zhao - Susquehanna

But why if the acquisition is completed, why is this not -- unless there’s another line which is the purchase of subsidiaries, so my understanding would be if it is a closed acquisition, already closed, then why should we not put the amount into that line?

Daniel M. Wu

It’s different. I think the line you look at, purchase and subsidiary net of cash acquired, it’s basically -- it’s the cash acquired. But if you look at this deposit paid to acquired subsidiaries, let’s say if we buy a company, let’s say for $1 million and we pay them 40% deposit, and if they actually let’s say missed their earn-out target in the year one, we actually can potentially get back some of the money, so that’s why it’s showing a deposit paid to acquired subsidiaries.

C. Ming Zhao - Susquehanna

Okay. Thank you very much.

Operator

Your next question comes from the line of Jackie Chan with CIBC World Markets. Please proceed.

Jackie Chan - CIBC World Markets

My name is Jackie Chan on behalf of Jason Helfstein from CIBC. We have a couple of questions regarding the quarter. First of all, [actual] announced rate card increases and how does the recent CCTV auction impact your view of 2008 pricing?

Daniel M. Wu

First of all on the rate card, we will do a rate card increase for January. We’ll put that on the website shortly. As we discussed previously, it would be similar as we did in 2007.

Regarding the CCTV impact, I’ll ask Jason.

Jason N. Jiang (Translation)

I think if you look at the CCTV rate card for 2008, actually it’s showing the fastest rate card increase historically. It actually provides us a very good comparable because TV advertising is our direct comparable media in China, so if that’s the benchmark for all advertising.

So if CCTV actually expects a very good year, we expect the pricing environment for 2008 to be very healthy. We do expect to increase price in January of 2008 10%, 15% for our rate card for the commercial location network, maybe higher for the other media and then of course in July, we also typically in the middle of the year before the Olympics in July, we’ll also have another rate card increase expected to be between 10% and 15%.

But in the Olympic cities, in key cities we expect the demand of our advertising to be very strong during this period, especially in 2008 before, during and after the Olympics. So during those periods, we believe our discount rate negotiation will be actually more favorable, so we will possibly be able to reduce our debt count to achieve better advertising returns for our media in 2008.

Jackie Chan - CIBC World Markets

Thanks. My next question is for Commercial Channel B, which was the bigger driver in the quarter, is it pricing or volume or both of them?

Daniel M. Wu

Commercial location Channel B is actually very similar. It’s not much different versus all our other commercial location network, so itself, we don’t -- given how we sell today, we don’t have a separate track of this revenue or ASPs by itself, because a lot of the sales are for commercial location [different channels on a [inaudible] basis], but it’s no different from the average commercial location business we have.

Jackie Chan - CIBC World Markets

Thanks. And my final question is what was the pricing growth in the tier two markets?

Daniel M. Wu

As we explained earlier, tier two markets, there are so many different tier two cities. If you look at Focus Media, we cover directly more than 50 cities, so if using Beijing, Shanghai, Guangzhou, Guangdong are tier one, then tier two cities would be more than 40. In those 40 cities, the pricing is very different in each city. It really depends on the size of the city, size of the network, how long we’ve been there, and also local economy of those cities.

For example in Chengdu, the price will be a lot higher than Xi'an, so I wouldn’t say the blended rate of tier two cities is a meaningful indicator of how our business going forward, because the blended rate for all tier two cities really depends on the contribution of different revenue by each of the tier two cities. But overall, as you see with the price environment very healthy, so we expect each of those cities continue to increase utilization rates, we’ll have pricing power in those tier two cities.

Jackie Chan - CIBC World Markets

Thank you very much.

Operator

Your next question comes from the line of Aaron Kessler with Piper Jaffray. Please proceed.

Aaron Kessler - Piper Jaffray

Just a couple of questions; first, on the online advertising acquisitions, were those all technology related or were there any content-based ones? And we had heard you might have acquired [PC-Pop]. I don’t know if you can indicate whether you did or not, and then I have one follow-up question.

Daniel M. Wu

What’s the company you said?

Aaron Kessler - Piper Jaffray

[PC-Pop], I believe.

Daniel M. Wu

Okay. First of all, the online advertising, what we do, as we talked about, we don’t do content. What we try to do is while the [inaudible] traffic we service web publishers, and so what we do is called Internet advertising service. Basically we provide additional market solutions for websites. So we don’t get involved in content, as we’ve discussed several times regarding our Internet strategy going forward.

Regarding specific acquisitions, we actually don’t open to discuss that but [PC-Pop] is not one of the companies we acquired, but I don’t think we want to discuss specifically what we are buying and what we are not buying.

Aaron Kessler - Piper Jaffray

Okay, and then as a follow-up question, last quarter I believe you indicated you are going to stop giving the metrics for the commercial segment and part of the reason was you are changing I guess the cycle times to more custom-based. What’s been the impact of that and what will be the impact of the changing cycle times going forward here?

Daniel M. Wu

I think first of all regarding the customized solutions, we already discussed earlier on the call when Eddie of Merrill Lynch asked this question. Regarding the cycle times, we actually believe in the long-term if, based on the average standing time in the lift lobbies in China, major cities, the potential cycle time can get to about 18 to 20 minutes but right now, in different cities we have a different cycle time. It really depends on the demand of the particular city, so hopefully that will answer your question.

Aaron Kessler - Piper Jaffray

And would that drive an increase --

Daniel M. Wu

Hold on one second.

Jason N. Jiang (Translation)

In addition to the commercial location network expanding cycles in major cities, right now in some of the, the Beijing, Shanghai, Guangzhou centers, we already have a base time of 15 minutes. We also look at extending the coverage of the commercial location network consumers eyeball through addition of frame 2.0 digital frames in not lobby floors but on the second, third level, fourth level floors near the elevators. It allows us basically in principle to use this different media, adding the media reach of our commercial location network and providing additional exposure time of eyeballs of those highly attractive consumers. So if you think about people waiting for the lift twice a day, lunch and the morning, the peak times, what we try to do is to expand that eyeball exposure from roughly about 300 seconds to 600 seconds, so allow our advertisers to actually do better and increasing the potential growth potential, revenue-generating potential of our media for the commercial location business.

Aaron Kessler - Piper Jaffray

And what’s the revenue impact if you’re going let’s say from a 12 or 15 minute cycle time to maybe an 18 to 20 minutes over time? What is the revenue impact? How should we think about that?

Daniel M. Wu

Revenue impact is similar -- similar to what we have done historically. If you think about three years ago, our business was on a six-minute cycle in Shanghai, so we already increased for six minutes to nine minutes and to 12 minutes and now to 15 minutes. So if you think about the published price of those [inaudible], it allows us to use the price we published for every 30-second spot, continue to increase the price for 30-second spot based on a similar rate of discount, so the ASP actually increased on the same pace as the published increase of list price. But at the same time, allows us to expand higher inventory because the cycle times are long.

So really, what we are doing today is no different from what we did in 2004 and 2005 and 2006.

Aaron Kessler - Piper Jaffray

Great. Thank you.

Operator

Your next question comes from the line of [Marisa Ho] with Credit Suisse. Please proceed.

Marisa Ho - Credit Suisse

I just have a quick couple of questions on the latest billboard acquisition; assuming you start updating those billboard, I mean within about six months to about a year, how long do you think it is going to take for the whole conversion process to be finished? Are we talking about substantially all of the 200 billboards being converted to LED going forward? And what is the CapEx you are budgeting for the conversion?

Jason N. Jiang (Translation)

I think we just acquired this outdoor digital company in China in the second quarter, so we are still in the process of evaluating all their sites. In terms of converting the traditional billboards to digital billboards, there are a lot of factors we need to take into consideration, such as lighting impact on the surrounding neighborhood, such as weight tolerance of the current construction, the current building, electricity supply and of course we need to get government approval if we convert a traditional poster to a digital billboard.

So all those things actually take time to work. Of course, it’s reduced -- the biggest entry barrier basically is access to the site itself, so we are in the process of evaluating all those things throughout the outdoor digital billboard network and we probably will be able to provide some idea in our 2008 guidance for CapEx in 2008. But at this time, we don’t have a specific number which we can provide to you because all those things we’re evaluating right now site-by-site.

Marisa Ho - Credit Suisse

Excellent. Thanks so much.

Daniel M. Wu

Sure. Operator, I think that will end the call.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect and have a good day.

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Source: Focus Media F3Q07 (Qtr End 9/30/07) Earnings Call Transcript
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